ACE2006: Competition & Competitiveness

What do we really mean by "Competition" and "Competitiveness"? These are important concepts, yet there remains a considerable amount of confusion about these terms and their meanings. For example:

“We would like to think that if famed intellectuals and powerful politicians talk about “competitiveness”, they must have something meaningful in mind. It seems far too cynical to suggest that the debate over competitiveness is simply a matter of time-honoured fallacies about international trade being dressed up in new and pretentious rhetoric. But it is.
Paul R. Krugman (MIT), “Making sense of the competitiveness debate”, Oxford Review of Economic Policy, 12 (3), 1996, p24.

Comparative Advantage Again - With an important aside on Exchange Rates
Trade, Growth and Agriculture
Competition & Competitiveness

Comparative Advantage again.

In simple terms, this fundamental economic principle says that it is better to concentrate your own scarce resources on making or doing the things that you are relatively good at (compared with the things you might otherwise do), and to trade these things for those that you actually want. By so doing, you will be able to be better off (in terms of the quality and quantity of the things you consume and use) than if you tried to do and make everything for yourself and be self-sufficient. Remember the gains from trade arguments - the concept of a production possibility frontier and the choice sets opened up by trade? If not - go and revise this.

There are two important implications of this principle.

First, even if you are less good at producing (say) beef than a lot of other people in the world, it will still pay you to concentrate on beef production if you are better at doing this (can produce more beef value with less cost, inputs and effort, and hence a greater margin) than you can by doing anything else you might do. In other words, the term comparative here means compared with what you might otherwise do, not compared with what others can do.
Second, although following the principle means that you will be as well-off as you can be, given your present resources and skills, it does not say that you will necessarily be satisfied with this standard of living - if you want to be better off, you need to adopt & adapt (get trained and educated and skilled) and accumulate. If you have few and poor resources, you will, in a competitive market, be poor. All comparative advantage says is that you can be less poor following this principle than otherwise.

This principle applies to individuals, to businesses, to localities, regions and nations - (consider what happens to international trade if we consider the whole world as a single community/nation - it doesn't disappear, it simly gets re-labeled). Of course, comparative advantages do not remain static - they change:

First, people get better at doing things and accumulate better and more resources (their production possibility frontiers (ppfs) move outwards).

Second, peoples tastes and preferences change, especially as their income, leisure time and general education changes. They will therefore alter what they are willing to pay for particular products and services, and this, too, can change the value of your comparative advantages, and may even shift your advantage from, say, beef production to the supply of farm holidays and conservation of remote landscapes and habitats. In other words, the terms of trade [(what you get (imports or purchases) for what you produce and sell (exports/outputs)] change depending on changes in ppfs and changes in preferences (and also get altered by changes in exchange rates in the case of internationally traded goods and services - which we have already dealt with, and is important).

Gains from trade are a result of exploiting the gains in productive efficiency arising from countries (or regions) concentrating on what they do best (produce most efficiently, or at least cost) and trading the products for those goods (and services) for which this region/country is less efficient (making domestic production more expensive).

In general, specialisation and trade is advantageous because:

natural conditions and natural resources are differentially distributed between regions, so some regions are better at producing (e.g) food and others better at producing manufactured goods;
resources are differentially distributed between people;
people are different: better at some things (or prefer to do some things more) than other things;
different people in different places have different preferences.

In short - trade relies on differences - if we were all exactly the same (the playing fields were all exactly level) - there would be no trade, even though there might be a good game - the analogy of level playing fields is not a very good one for trade and comparative advantage. Nor, incidentally, is the idea that economic competition is the same as a game or race - that the winner takes all. Not in economic competition, which is much more like evolution and natural selection - the survival (and replication) of those habits, practices, institutions and technologies which fit best with the socio-economic environment and political climate. The rich an economy, the wider the variety of surviving and replicating businesses and households

So, markets happen to allow people, sectors and regions to specialise and trade with each other, which in turn encourages the most efficient use of the available people and resources - producing more of what is wanted (ensuring effectiveness - doing the right things) with a minimum use of resources (i.e. ensuring efficiency - doing things right). In free markets, this specialisation and trade will tend to differentiate earnings of different factors (including people) according to their relative scarcity - the availability of the particular skill or resource compared with the demand for the use of the skill or resource (which in turn is derived from the demands for the products and services the resource produces).

Within a country, people and capital can and will move. There will be a flow of people and capital away from those regions and sectors which have relatively abundant resources and hence low returns towards those regions and sectors which have scarce resources and high (or more secure) returns. In the limit, this flow will equalise returns to resources (given their quality relative to demands for their particular capabilities) throughout the country. Differentials in rates of return will then reflect different qualities and be driven by the relative demands for these distinctive capabilities. The scarcer the particular resource capability relative to the demands for its use, the higher its return and the greater the incentives to create and develop other resources (people, land, capital) to imitate or duplicate these particular capabilities.

In the limit, within a country (defined here as a region within which there is free movement of capital and labour), trade and markets will tend to result in an equalisation of prices for goods and services, and also an equalisation of returns to capital, labour and land (quality differences aside) across all sectors and regions. Differentials will simply reflect the costs of moving goods and services from one place, time or form to another, and similarly the costs of moving and changing labour, land and capital from one form or place to another. The greater the costs of transformation, the greater will be the persistent differentials.

For example, if farmers are really determined to continue to be farmers whatever their returns, then they must expect the differential between their earnings as farmers and those in the rest of the economy to grow wider and wider (since the total earnings of farming relative to the total economy will inevitably decline as economies grow and spend more on other things than food)

Between countries, however, it is typically assumed that capital and labour mobility is more restricted - it is more costly to re-locate capital, and especially labour, between countries than within. People do not generally want to move, and will only move if the attractive incentives to move (or repulsive penalties for staying put) are sufficiently great. So, international labour, land and capital return differentials might be expected to be larger than within country differentials.

Free trade, however, will still tend to equalise prices between countries (with remaining differentials simply reflecting marketing costs) - the purchasing power parity theory of long-run exchange rates (see above).

Rich countries, in this logic, are those with greater amounts of capital (especially) and land per head of the population and greater levels of skills, experience and education per head. These resources earn more per head than in poorer countries. Economic migration happens because people want to earn more, so they tend to gravitate towards those regions of the world with higher earnings.

There are two major counteracting forces preventing economic migration from equalising international wages and factor returns: a) people (especially) are typically reluctant to move away from their birthplaces, families and roots. The stronger and longer are the roots, the more reluctant they are to move, being content to remain relatively impoverished. The more impoverished they are, the less easy it is to move because the costs and risks are too great; b) the richer communities attempt to preserve and conserve their own wealth by preventing incomers and immigrants. Unless countries find themselves desperately short of particular forms of labour (typically unskilled, low waged or for menial or unpleasant jobs) entry to the richer regions will be restricted. Hence, wage equalisation is slow, costly and painful. - and depends on the poor managing to accumulate more capital, and find more things to do and produce with their labour.

Capital, however, is increasingly internationally mobile - but the ownership of capital is typically restricted, returning the returns on capital to the owners rather than the residents or workers. Hence the reluctance of developing countries and economies in transition (the Former Soviet Union, for instance) to welcome offshore or foreign capital. On the other hand, the owners and managers of capital (Pension funds, Insurance companies, etc.) tend to be risk averse, and prefer to invest in places which are known to be secure and where returns are relatively certain - which is often not the less developed regions of the world. In addition, the owners of the capital tend to be in the richer areas of the world, so even when capital is invested in less developed regions, the returns flow back to the developed regions and richer people.

As a consequence, there are good reasons to suppose that the gains from trade are differentially distributed between the haves and the havenots, with the gains accruing largely to those that already have, despite also helping those who have not.

Meanwhile, apparent comparative advantages between countries will tend to reflect the following:

different technological conditions - really a reflection of differential capital availabilities per head;
different mixes of factors of production (different amounts and qualities of land, labour, capital and management) - so that countries with large areas of cropland per head (like North America) will tend to be agricultural exporters, while those with large numbers of people will tend to have comparative advantages in goods requiring large labour inputs.

Which give rise to different shaped and positions for the PPF, which have different slopes for different countries or regions,

And also

Different Tastes and requirements by consumers;

Which give rise to different shapes and slopes for the consumer indifference curves. Tastes (Demands) differ because of climate, history etc. Not usually emphasised in textbooks but may be important in some instances - Skis, canoes and central heating equipment of limited use in Sahara, oil drilling equipment not much use in Germany or Japan (but German firms may be able to make them relatively efficiently).

ALL OF WHICH CONTRIBUTE TO COMPARATIVE ADVANTAGE. [do not do unto others as you would they should do unto you - their tastes may not be the same (Shaw)] So, relativity discovered in economics (by Ricardo (1772 - 1823) as an extension of the Adam Smith logic of markets) well before Einstein did so in physics!

All of the conditions determining comparative advantage, however, (even land endowments, through land improvement - drainage, irrigation etc.)) change through time. Hence the story of the industrial revolution: UK's comparative advantage in engineering, industry etc. based on coal), food in the Colonies, then changing with "mass production" and labour intensity, with declining industries tending to be protected (that is shielded in some way from the world market), since trading conditions encourage the re-allocation of resources away from those sectors in which the country no longer has a comparative advantage.

Furthermore:

Specialisation can lead to economies of scale (reducing costs of production and increasing comparative advantage);
Specialisation can also lead to learning by doing, again reducing costs of production and increasing comparative advantage;

which leads to arguments that infant industries (those seeking to grow and expand) should be protected to encourage the development of economies of scale and technological improvement.

Trade Restrictions (as one of the ways in which producers try to protect their markets from competition)

These logics almost inevitably give rise to trade restrictions between countries, with the more common reasons for these restrictions being:

National Security and independence from potential or actual enemies of the state (e.g. food security - but, what about the resources necessary to grow, harvest, process and distribute the food - how secure are these?)
Tariffs to improve terms of trade (driving costs of imports down) if the importing country is large enough in the world market to have this effect - giving rise to the idea of an OPTIMAL TARIFF - one which offsets the economic welfare costs of restricting trade by increasing the tariff revenues because of the depressing effect of restricting imports on world (import) prices. Obviously, there is an optimal level to the tariff in this case, since if the tariff is set too high there will be no imports (the tariff is prohibitive) and there will be no tariff revenues. But - what about the effect this has on other trading countries - who lose as much as this country might gain? Retaliation is likely, plus there will be a general equilibrium effect on their incomes, and hence on their spending on our exports.
Keep money in the country, though why, if there is nothing to spend it on?
Maintain wages/incomes in an industry which would otherwise suffer from international competition, but at the expense of consumers who would prefer to have access to the imports
For tariff revenue to the domestic government's budget - but tax usually regressive - better to tax all sales rather than just imports.
Protect and expand home market - but lower GNP (consumption), also danger of retaliation from exporting countries, who cannot then afford to buy the home country's exports, and will seek to retaliate by limiting its own imports - reducing trade and economic growth all round.
Competition from cheap labour or highly productive foreigners (but Gains from trade depend on these cost differences. Cheap cloth - but sewing machines? designs? radios, bicycles?)
Foreigners will pay the costs of import protection - true, depending on elasticity of Rest of World supplies, but what will be the response of the rest of the world? Lower growth and less demand for their imports.
Prevent unemployment in uncompetitive sectors - but like painting a hanging man's face red and hoping that this will save his life (which is obviously in danger because his face is blue)
Infant Industry (see above). - but how do we know when the infant has grown up, and can it grow up and become independent if it is continually protected?
Dynamic arguments: Comparative Advantage changes - leaves old industries unprotected and needing time to adjust, so temporary tariffs may be justified to allow time for adjustment.

Trade, Growth and Agriculture. The conventional story of agricultural development as growth occurs is that the farm sector, faced with price and income inelastic demands for its products, will tend to decline relative to the rest of the economy. Resources move out of farming and into other sectors as incomes and opportunities grow in the rest of the economy (e.g., Anderson, 1995). However, for economies previously encumbered with inefficient resource allocation and facing barriers to trade, liberalisation can result in relative growth in the farm sector as it becomes more efficient and as trade opportunities are opened up. Brazil is a classic example. Since 2003, Brazil has improved its macroeconomic stability, built foreign reserves, reduced debt, kept inflation rates under control and committed to fiscal responsibilities. After witnessing unprecedented economic growth in 2007 and 2008, the global financial crisis finally hit Brazil. Brazil’s currency and stock market saw huge fluctuations as foreign investments dwindled, demand for commodity exports dried up and external credit increased. However, Brazil was one of the first emerging markets to stage a recovery, with GDP growth returning to positive levels. The Central Bank predicts growth of 5% in 2010.

In simple terms, a country's comparative advantage depends on its resource endowments - the more land and labour it has relative to capital, the more likely it is to have a comparative advantage in farm products. As Anderson (1995, p 119 - 120) remarks: "since the usable capital stock per worker in those (Central and Eastern European - CEE) countries is low relative to the stock of agricultural land and other farm capital per worker, their comparative advantages during the next decade or so are likely to be in primary products and standard technology manufactures until new stocks of industrial capital accumulate (Hamilton and Winters, 1992; Anderson, 1992, 1993)". He goes on: "So it is in these product areas that access to EU markets is most sought after. While to date (1995) the EU has been resisting, at the behest of its domestic interest groups, there are serious concerns about immigration from, and/or political upheavals in the transforming economies should those economies not begin to prosper soon." Anderson uses the illustrative framework suggested by Leamer (1987) to summarise relative resource endowments for different countries (Figure 1).

In this Figure, N denotes land resources (here measured as cropland); L shows population; C indicates industrial capital (as well as other produced capital, including skills and technology). The approximate location within this triangle of each country (or region) can be measured relative to the world average, which is taken as the numeraire.

Thus, the location of the world on this diagram is at point W (we do not, yet, trade with any other 'world'). Countries which lie above the line AC have relatively greater areas of cropland per person than the world average, and are likely to have a comparative advantage in farm products . Countries lying to the left of line NB are relatively poor compared with the world average, implying that they also have less capital (including human capital) to attract and earn income per person than the world average. As an illustration, the approximate locations of Poland (P), Hungary (H) and Germany (G) are indicated on the diagram. From this simple and highly aggregated analysis, it seems clear that these two Central European Countries (CECs), at least, are likely to have a comparative advantage in farm products (along with most of North America, South America, sub-Saharan Africa, Australasia and much of south-eastern Asia and the Former Soviet Union).

The implication of this simple analysis is that liberalisation (opening up of the world economy to freer trade) should enable Poland to take advantage of its natural comparative advantage in farm products, which in turn should lead to growth of the domestic economy, especially the farm and related sectors. There is now little doubt that open economies perform better than closed economies (see, e.g. Edwards, 1993, Thomas et al., 1991, and Greenway and Sapsford, 1994). As Falvey, 1997, observes: "the beneficial resource allocation effects of allowing freer trade are now widely accepted, although under the standard assumptions they appeared likely to be very small." (p2). However, he goes on: "Recent developments in trade theory suggest that the resource misallocation effects may be much higher than is conventionally estimated. - The reasons have to do with the dynamic effects of trade liberalisation, where, for example, Romer, 1994, emphasises innovation and introduction of new technologies, new services, new productive activities and new types of capital and inputs, all of which tend to be stifled under more protectionist and regulated markets. In turn, such regulations and protection (and central control) encourages economic resourcefulness to be channelled towards beating (or farming) the regulations and lobbying bureaucracies (activities which are substantially unproductive, but earn rents for those who control the regulations or own the quota rights etc.) rather than on developing and growing markets (see, e.g. Feenstra, 1992) - the rent seeking phenomenon, closely associated with bribery and corruption."

Krugman (see reference at head of this page) suggests that there are four major characterisations of trade views - one of which (in particular) tends to strongly support trade intervention, restriction and protection (often using the arguments above in support of trade restriction or "management") - the mercantalist. For the mercantalist, trade is a definite competition between countries, exports are good, generating jobs, incomes and profits at home, imports are bad, equivalent to exporting jobs to other countries. Although this sounds very protectionist, mercantalists have to recognise that they live in a world of more than one country, and so have to do deals with other countries, and other mercantalists, so end up 'trading' access to international markets with each other, and gradually reducing trade restrictions, albeit with strong conditions that the resulting freer trade should be fair (at least to them, if to no one else) - which is pretty much the way the WTO works. The other three characters in Krugman's view are: the Classicist (the economists' understanding of comparative advantage and the benefits of trade); the Strategist (who believes that imperfections in the market (such as major economies of scale - equivalent to natural monopolies, and also imperfect competition - oligopoly) can give reasons for strategic intervention in trade (the 'new trade theory'); the Realist - who accepts that there may be theoretical justification for intervention in certain restricted circumstances, but that the practical gains from such intervention are typically very small, and the dangers (and costs) of the interventions being abused by the powerful, and extended beyond their narrow limits, are far more important.

Krugman outlines "The Narrow and Broad arguments for Free Trade" (AER, Vol. 83, No. 2, Papers and Proceedings of the Hundred and Fifth Annual Meeting of the American Economic Association (May, 1993), pp. 362-366), from a broadly 'realist' perspective. This short paper admits that the simple story of comparative advantage hardly explains the trade patterns and flows that we actually see. Economies of scale (including those of advertising) and external economies (companies grow better in neighbourhoods well serviced with skilled labour forces, transport and communication links, R&D facilities and like-minded companies etc.) are also important. Furthermore, the world is not 'perfectly competitive' - information is not universal but scarce and costly to obtain and process into knowledge; monopolistic competition is more prevalent than perfect competition. The simple economic argument in favour of free trade, therefore, does not hold in practice. Does this mean that countries (governments) could make their people better off by pursuing so-called "Strategic Trade Policies" which seek to provide preference to domestic companies over their foreign rivals? No, Krugman answers, because other countries will retaliate, and we will all be worse off as a consequence, rather than better off. If and when markets 'fail' - fix the failure at source (low wages - educate and train the work force - etc.), using trade policy will end up being a 'cure' worse than the disease.

[Refs:

Anderson, K., 1995, "Impacts of the New Multilateral and Regional Integration Agreements on Agricultural Competitiveness of Advanced Economies", in Agricultural Competitiveness: Market Forces and Policy Choice, Peters, G.H. and Hedley, D.D. (eds), Dartmouth, p 110-125.
Falvey, R., 1997, "Trade Policy and Growth Theory: Recent Advances", Discussion Papers in Economics, DP 97/3 University of Nottingham, UK.]

Competition and Competitiveness at the Sector level

Asked to define competition, most economists will rehearse the conditions for perfect competition: freedom of entry and exit to and from the industry, many producers and consumers, all of whom individually are price takers rather than price setters; freedom of information (if not prefect information); homogenous products. Lay people, on the other hand, will likely talk about races, conflicts, competitions (winner takes all), survival of the fittest, laws of the jungle, brute strength etc.

A more sophisticated economic response might well include:

the economic concept of pure profits - returns to factors of production over and above their opportunity costs, which will (so long as there are no barriers to entry into the industry) attract others into the profitable business, increasing supplies and driving down prices until these pure or excess profits are eliminated.
the associated concept of normal profits - those which are equal to the opportunity costs of the factors of production involved, providing just enough of a return to persuade those involved to stay in this business rather than moving to something else - which are the motive force of competition and the economic system - as ways in which people can make their livings.
the processes of competition ensuring that pure profits cannot persist anywhere in the system - since the existence of pure profits will attract others into the sector or industry, competing away any additional profits over and above those necessary to cover the actual and opportunity costs of production (and marketing).

However, there is no commonly accepted measure of competitiveness. Comparison of reported costs of production between different firms, different regions or different countries immediately runs into three major problems:

Quality (and thus willingness to pay by consumers and users) differs between firms, regions, and countries - hence making costs of production only one part of the unspecified equation measuring competitiveness;
Protection and insulation of local or domestic markets from external or international competition - which will have the effect of increasing the cost structure of the protected industry to eliminate the pure profits which would otherwise exist;
The opportunity costs of the underlying resources (land, labour, capital and management) which depend critically on the condition of the rest of the local and trading economies

However, if we abstract from the problem of quality for the moment (i.e ignore it, and assume that the products are homogeneous between countries or regions), it should be possible to compare the values added to the opportunity costs of the resources used between sectors, localities or countries.

Thus, we could measure the opportunity costs of the domestic resources (land, labour, and capital) used in the production of a good per unit of value added measured at border prices (the unprotected and unsupported prices), where value added is the difference between the sale price of the good and the cost per unit of the inputs used in its production. This ratio is known as the Domestic Resource Cost (DRC).

DRC = [Opportunity Costs of Resources used] divided by [Value Added produced measured at Border (unprotected) Prices]

So long as this ratio is less than one, then the production will be capable of generating a positive return over and above opportunity costs to the local or domestic resources being used - i.e. capable of generating a pure or excess profit. In a system of perfectly competitive markets, all DRCs would be equal to one - no pure or excess profit opportunities anywhere in the system. More generally, sectors with DRCs less than one would be expected to grow (to be competitive), while those with DRCs greater than one would be expected to decline (be uncompetitive) unless they can improve their productivity (or improve the value of their product by adjusting the quality to match consumers willingness to pay).

In practice, this approach is plagued by problems:

The measure of border prices, which depends on:

the exchange rates used (see above),
the extent to which current world prices themselves are competitive (undistorted by other protective measures elsewhere in the world)

The measure of the opportunity costs of the domestic resources used - also known as their shadow prices - the returns these resources would be able to earn elsewhere in the local economy. What is the labour, land and capital used in the domestic production worth if it does not work in this sector or produce this product?
the technical input/output coefficients, which translate resources used into value added produced - how much resource, and in what mix, is required to produce each unit of value added?

The reference below summarises several studies of CEC agriculture which seek to measure the DRC for different agricultural products in these countries, and summarises the methods used to cope with these problems. The conclusion of this paper is that CEC cereal production (especially wheat and oilseeds) is generally competitive, while livestock production is not. However, especially for milk, the international (border) price is likely to be severely depressed by protective policies being pursued elsewhere in the world. In addition, the world market typically represents the residual market for livestock products - and is subject to wide fluctuations - small world oversupplies have considerable effects on world prices, making production everywhere in the world unprofitable at low prices - the signal to the world to reduce production from these excessive levels.

When EU prices, rather than world prices, are used as the comparitor, the competitiveness as measured by DRC generally improves - since EU prices are generally higher than world prices, though this also applies to the prices of inputs used to generate value added.

But, does DRC measure comparative advantage? As pointed out above, in a world which fully exploits all the efficiencies of pursuing comparative advantage, specialisation and gains from trade, all DRCs would be 1 - and we would not be able to measure comparative advantages through this route. Comparative advantages would show up in such a world in trade flows, and associated balances between production, imports, exports and consumption levels in various localities, regions and countries.

But, in practice, current trade flows are distorted - competition is not the only thing driving economic activity and pursuit of profitable opportunities - governments interfere with trade and prices (for their own reasons). The effects of these interventions (and of other inefficiencies), may well be illustrated by DRCs, but these measures may NOT illustrate any underlying comparative disadvantage. For instance, suppose we measure the DRC for a sector (like cereals) in a country where support for agriculture is commonplace. The opportunity cost of land will be high, because of the support, as will the opportunity cost of capital (since there will be more capital used), as will the cost of labour (since there will be more people trying to earn a living from the industry than otherwise). DRCs, in this case, are quite likely to show that the sector is uncompetitive. However, if and when the support were to be removed, the employment of factors in the industry would adjust, as would the value of land, and the sector would be shown to be competitive after all.

Reference to Domestic Resource Cost measures: Mat Gorton and Sophia Davidova, on CEC agriculture's competitiveness and DRC Measures

Competitiveness at the business level - where it matters

Economics largely deals with commodities - all units of which are considered identical to each other. (Important exceptions are the monopolistic competition model and the goods (services) attribute approach to demand - following Lancaster). The real world has moved on from commodities, and now increasingly deals with products, which are differentiated in a variety of real or perceived ways, so that one car is not the same as another - it matters who made it and who sold it to you as well as what model, colour, and specification it is.

Competitiveness deals with the notions of whether one product (and thus its supply or marketing chain) can compete in the market place and sustain, if not improve, its share of the total market and the total value it can add to the raw materials as the products move through the chain. Although the principle of comparative advantage still operates, the extent of competition and competitiveness involves rather more than simply how good you are at making this product compared with your ability to make other products.

Following Kay (Foundations of Corporate Success): the concept of the production/marketing processes used here is very simple - it simply involves organising your resources (land, labour, capital and management) to produce products which are wanted (that is, for which people are prepared to pay good money). While it will still pay you to produce the products which you are best at, there is now more to it than that.

Inclusion of the key elements of products, as opposed to commodities, suggests that competitiveness will depend on being distinctive from the competition in ways which are, and will continue to be, regarded as valuable by the user. This implies that the product (or the resources which are needed for its production) are relatively rare, otherwise the consumer or user can turn to other sources than yours. It also implies that there should be few, ideally no imitations or substitutes available, since the existence of either good imitations or substitutes for your product will reduce the amounts consumers and users are willing to pay for your product. In shorthand, these attributes of competitive products (valuable, rare, inimitable, unsubstitutable) can be labelled as the products competitive advantage (which is obviously rather different from and more sophisticated than comparative advantage).

What is that makes firms (production/marketing systems) and their resources distinctive? Since technologies are frequently easily copied and most resources are fairly commonly available, distinctiveness must rely on more intangible aspects of business organisation. Kay identifies four key elements to a firms (or marketing chains) distinctiveness:

the network of relationships the firm has with its suppliers and customers, as well as the internal networks the firm uses to keep its parts and people working together - which together Kay calls architecture;
innovative capacity, reflecting the extent to which you identify new customer requirements and new niches and invent or discover new, different and valuable ways of meeting these emerging and growing requirements - which, as Kay points out, is frequently and strongly associated with architecture above, since it involves continual and accurate transmission of final customer requirements back up and through the marketing chain to the producers;
the reputation of the firm or chain, which is clearly of vital importance in signaling to the customer the quality and reliability of products, especially for search products - which customers buy infrequently and so have limited personal experience of the actual quality, value for money and reliability of the product;
strategic assets - the extent to which you have control over a limited resource (such as a gold mine) or have a naturally or legally restricted market, and can thus trade on a degree of monopoly power.

Kay labels these firm or chain characteristics (architecture, reputation, innovation and strategic assets) as the firms distinctive capabilities.

Competitiveness, according to these concepts, now involves harnessing a firms distinctive capabilities to the competitive advantage of the actual and potential products (and their underlying resources), with the primary objective of adding value to the product (as a combination of inputs and resources), since it is the added value which provides the income and profit to the firm or chain. It is this combination of competitive advantage and distinctive capability which determines the competitiveness of the firm or chain.

Major Ref:
John Kay, Foundations of Corporate Success, Oxford University Press, 1993.

So what for British Agriculture?

It is commonly thought that British agriculture will tend to bifurcate into large scale, intensive or ranch/prairie style farming systems on the one hand and small, part-time hobby or recreational 'farms' on the other, as farming households and businesses try to find their best fits with an increasingly freer trade and unsupported industry. However, consider the following representation of the possible futures for UK agriculture:

The horizontal axis, measuring the % of income derived from agricultural production (0 to 100%) shows the typical range presumed in the bifurcation argument - between the pure hobby or recreational farms on the right hand end to the fully commercial and internationally competitive businesses on the left hand end.

However, the options of generating 'original' products, as opposed to mere commodities (indistinguishable from competing commodities elsewhere in the world) open up the possibility of generating additional value-added by making the products distinctive and Kay-competitive. This option is represented here by (notionally) measuring the value added (to the same basic inputs) relative to the industry champion (the business adding most value to the same basic inputs).

The market is tending to evolve towards more differentiation, as we would expect, (considering the market as little more than the social equivalent of natural selection) - even the supermarkets are differentiating (organics, 'taste-the-difference' and other premium brands), while the fastest growing sector of the food market (restaurants etc.) is also continually differentiating. This, coupled with a growing willingness to pay for the 'countryside' (conservation, amenity, recreation, environment - care goods and services), which is represented by the recreational businesses at the RH base of the diagram above, opens up the original (craft and care) option of farm businesses, and widens the scope for differentiation beyond the narrow confines thought of in the typical bifurcation view.

One response to the Strategy for Sustainable Food and Farming (the Curry Report) was the establishment of the "dunnhumby Academy for Consumer Research" (now called the Centre For Value Chain Research (VCR² ) at the University of Kent) which uses the complete Tesco club card database to explore consumer preferences based on their actual willingness to pay for differentiated products. In their words: "For upstream stakeholders (farmers, farmer controlled businesses and small food producers) the challenge to add value and differentiate is particularly difficult, which the Government has recognised in its strategy for sustainable food and farming. ...VCR² offers a free service providing analysis of supermarket shopper behaviour for individual products (e.g. loose kentish new potatoes), or groups of food products (e.g. new potatoes), that will reveal detailed insights into which products are growing the fastest, who is buying them, where they are buying them and what else they are buying."

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