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Competition & Competitiveness 

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• Summary & Critique of Comparative Advantage logic Plus an Important Caveat on the notion of National Competitiveness
• A Case Study: the US/EU Banana war
• Trade, Growth and Agriculture - the Central and Eastern European Case
• Competition & Competitiveness
• Marketing Margins: Law of one price, &the case of the Single Desk Seller
• Competitiveness

In simple terms, this principle says that it is better to concentrate your own scarce resources on making or doing the things that you are relatively good at, 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.  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) than you are at doing anything else. 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 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.

First, people get better at doing things and accumulate better and more resources (their production possibility frontiers (ppfs) move outwards). As they do, so the value of the things they produce will tend to decline, simply because more of them are being produced, and because they are costing less per unit to produce

 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 change depending on changes in ppfs and changes in preferences (and also get altered by changes in exchange rates in the case of internationallly traded goods and services).

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 servies) for which this region/country is less efficient (making domestic production more expensive). The analytical logic of this argument can be found in any of the Economics Principles textbooks

Summary & Critique of Comparative Advantage logic

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 better at some things (or prefer to do some things more) than other things;
• different people in different places have different prefences

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 with a minimum use of resources (i.e. ensuring efficiency). 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 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 economic principles notes).

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 desparately short of particular forms of labour (typically unskilled, low waged or for menial or unpleasent jobs) entry to the richer regions will be restricted. Hence, wage equalisation is slow, costly and painful.

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.

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.

And also

• Different Tastes and requirements by consumers;

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;

Trade Restrictions

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 necesary 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 contunually 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.

National Competitiveness??  An Important Caveat on the use of the word (and concept) of Competitiveness as applied to countries and country comparisons

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A Case Study on Trade Restrictions - The Banana dispute.

Trade, Growth and Agriculture - the illustration of Poland

In simple terms, a countrys 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 (op. cit., 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 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. 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 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 FSU).

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.

[Major Refs:

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

Competition and Competitiveness at the Sector level

A more sophsiticated 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 purte 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 perusade those involved to stay in this business rather than mving 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).

• 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 woujld 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

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 prefectly competitive markets, all DRCs would be equal to one - no pure or excess profit opportunities anywhere in the system.  More generally, sectors with DRCs greater than one would be expected to grow (to be competitive), while those with DRCs less 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,
• 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.
• 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?  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?

When EU prices, rather than world prices, are used as the comparitor, the competitiveness as measured by DRC generally imporves - 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 common place.  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 firm level

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.

The concept of the production/marketing processes used here is still 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 technolgies 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;
• the reputation of the firm or chain, which is clearly of vital importance in signalling 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;
• innovativecapacity, 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;
• 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.

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 Refs:
John Kay, Foundations of Corporate Success, Oxford University Press, 1993.
R.E. Westgren, Firm Resources, Industrial Organisation and Austrian Economics: The Bases for a New Strategic Management Approach to Competitiveness, in Agricultural Competitiveness: Market Forces and Policy Choice, Proceedings of 22nd. Conf. International Ag. Economists, Harare, Aug, 1994, Peters, G. and Hedley, D (eds.), Dartmouth, 1995

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