Global Competitiveness

Globalization
Meaning of Globalization

• Globalization means increasing internationalization of production,

distribution, and marketing of goods and services.

• In a broader sense, it refers to the expansion of global linkages,

the organization of social life on a global scale, and the growth of
a global consciousness, hence to the consolidation of the world
society.

• It is a complex economic, political, cultural, and geographical

process in which the mobility of capital, organizations, ideas and
peoples has taken on an increasingly global or transnational form.

• Economic globalization refers to the process that advancing the

integration of the world economy through trade and investment.

2
 Forces driving Globalization

• Technological change:
– Production
– Communication & information
– Transport
• Liberalization of trade & investment:
– Tariff, non-tariff barrier reductions
– Liberalized financial transactions
– International financial markets

3
 Waves of Globalization

• 1st wave: 1870-1914

– Falling tariff barriers
– improved transportation
• 2nd wave: 1945-1980
– Agreements to lower barriers again
– Rich country trade specialization
– Poor nations left behind
• 3rd wave: 1980-present
– Growth of emerging markets
– international capital movements regain
importance
4
 Pros & Cons of Globalization
Pros

• Higher economic growth

• Increased efficiency of business (higher
productivity)
• Benefits to consumers (global competition and
cheap imports keep prices low and inflation at
bay)
• Higher living standard
• Encourages technological development and
innovation
• Capital inflow (e.g. FDI) to less developed
economies
• Higher return on investments
5
 Pros & Cons of Globalization

Cons
• Job losses (millions of US jobs lost to
imports or production abroad)
• Widening income inequality
• Downward pressure on wages
• Loss of economic sovereignty
(interference from MNCs, World Bank, IMF,
WTO etc.)
• Tax avoidance
• Environmental degradation
6
Global Competitiveness
Theories

The Journey from

Comparative Advantage
to
Competitive Advantage

7
 Trade Based on
Absolute Advantage

• Absolute Advantage – Adam Smith (1776)

➢ The ability of a country to produce a good using
fewer resources than another country
• If U.S. workers are more productive in
producing machines (e.g. computers) and
Indian workers are more productive in
producing cloth (e.g. ready made garments),
then
➢ The U.S. has an absolute advantage in machine
production.
➢ India has an absolute advantage in cloth production.
 Principle of Absolute Advantage

❑Assumptions:
Labour is the only factor of production and it is homogeneous.
Cost or price of a good depends exclusively upon the amount
of labour required to produce it. Thus, if U.S. uses less labour
to produce a machine than India, production cost (of machine)
will be lower in U.S.

So Adam Smith’s concept of cost was founded upon

the Labour Theory of Value

In a two-nation two-product world, international

trade and specialization will be beneficial when one
nation has an absolute cost advantage in one good
and the other nation has absolute cost advantage in
the other good.
 Absolute Advantage- An illustration

A case of Absolute Advantage when each nation is more

efficient in the production of one good

Country Output per labour day

Machine Cloth (yards)

(no.)
India 2 15

United States 5 10
 Absolute Advantage

• India could get machines cheaper from U.S.

• U.S. could get cloth cheaper from India.
• Both countries benefit if trade occurs.
– U.S. produces machines and exports them to India
– India produces cloth and exports it to the U.S.
• World output increases by 3 machines and
5 yards of cloth.
 Gains from Trade: Absolute Advantage

• The Gains from Trade Country Output per labour day

= The increase in Machines (no.) Cloth (yards)
world production and
consumption India -2 15

resulting from United States 5 -10

specialization and Change in +3 +5
trade. World
Output
➢ This increase in output
is allocated between
U.S. and India through
international trade.
 A Question

•What happens if U.S. can produce both

the goods (machines & cloth) more
efficiently than India?
•Will there be still trade possible between
U.S. and India?

•Answer is YES according to the

Principle of Comparative Advantage
 Principle of
Comparative Advantage
• The Principle was developed by David Ricardo (1817)
• According to Ricardo mutually beneficial trade can
occur even when one nation is absolutely more
efficient in the production of all goods.
• The basis for international trade was comparative cost
differences among the nations
• Countries often develop comparative advantages
resulting from natural advantages and acquired
advantages
 Ricardo’s Comparative Advantage
Principle: Assumptions

• World consists of two nations, each using a single input

labour to produce two goods
• Each nation has a fixed endowment of labour and labour is
fully employed and homogeneous
• Labour is perfectly mobile within a nation, not between the
nations
• The level of technology is fixed for both nations
• Costs don’t vary with the level of output and are
proportional to the amount of labour used
• Perfect competition prevails in all markets
• Free trade between the nations (no. govt. intervention)
• Transportation costs are zero
• Firms seek profit maximization, while consumers utility
maximization
• No money illusion
• Trade is balanced
Comparative Advantage-An Illustration

Country Output per labour day

Machines (no.) Cloth (yards)

India 1 5

United States 5 15

U.S. is more efficient than India in the production of both the

goods viz. machines and cloth. But U.S. is five times more efficient
in computer production, but only thrice as efficient in cloth
production. So U.S. has greater absolute advantage in machines
than in cloth. India has lesser absolute disadvantage in cloth, as
compared to machine production.
 Trade Based on
Comparative Advantage

U.S. has comparative advantage in machines and

India in cloth. Each nation should specialize in the
product in which it has comparative advantage
and export it for obtaining other good(s). So,
India should produce cloth and export it to the
U.S., who, in turn, should specialize in machines
production and buy cloth from India.
Comparative Advantage in Money Terms

Country/
Product Computer RMG Av. wage/day
India 1 5 Rs. 900
US 5 15 US $90
Cost of Production (in respective country currency)
India Rs. 900 Rs. 180
US $ 18 $6
Cost of Production (in a common currency)
1 US $= Rs. 40
India $22.5 $4.5
US $18.0 $6.0
 Comparative Advantages:
Summary
• Even though U.S. has an absolute advantage
in both goods, India has a comparative
advantage in production of cloth.
• Even if U.S. has an absolute advantage in
both goods, beneficial trade is possible.
• If both countries specialize according to their
comparative advantage, they both gain from
this specialization and trade. World output
also increases.
 Limitations of the Comparative
Advantage Theory
• Ricardo considered labour as the only factor of
production. But in reality labour is only one of
several factor inputs.
• It ignores the concept of opportunity cost.
• The Ricardian framework would collapse if the
trading partners are of unequal size. One
country’s supply should be sufficient enough to
meet its trading partner’s demand.
• It does not consider other costs associated with
trade e.g. freight, insurance etc.
• The price of a product is determined not only by
costs of production, but also by demand. But no
role was assigned to the demand for products in
determining trade between nations.
 Evidence on Comparative Advantage
• Ricardo’s theory implies that each country will
export goods for which its labour is relatively
productive compared with that of its trading
partners.
• However, comparative advantage in a product
may vanish over time when productivity growth
falls behind that of its foreign competitors
• Productivity may also change due to change in
technology
• Is then the Theory of Comparative Advantage is
valid in real world?
• The first test on the model was done by a British
economist G.D.A. MacDougall in 1951
• Examined export patterns of 25 industries
between US and UK.
• His results strongly supported the Ricardian
Theory
 Evidence on Comparative Advantage

• Another study was undertaken by Stephen

Golub, who examined the relationship between
relative unit labour costs (the ratio of wages to
productivity) and trade for the United States vis-
à-vis UK, Japan, Germany, Canada and
Australia.
• He found that relative unit labour cost helps to
explain trade patterns for these countries.
• The US and Japanese results lend particularly
good support for the Ricardian model.
 India’s Comparative Advantage
• What are the sectors that India has
comparative advantages?
• According to a study by the ICRIER (2005)
India has comparative advantages in a few
sectors, such as
➢ Organic chemicals,
➢ Textiles (cotton, silk, carpets, articles of
apparel accessories etc.),
➢ Iron & steel
➢ Pearls, precious stones, metals, coins etc.
➢ Tea, coffee & spices
 Factors Contributing to India’s Comparative
Advantage in ITES sector
• India’s comparative advantage in ITES sector is well
recognized world over ( India has become an
attractive centre for BPO/ KPO activities)
• Factors leading to India’s success in the sector are:

➢ English speaking population

➢ India’s Education System (specially technical
education)
➢ Improving infrastructure (e.g. telecom )
➢ Entrepreneurial Skills
➢ Govt. Policy (less interference in the sector)
➢ Others
Factor Endowment Theory
 The Background

• So far relative price differentials among nations

formed the immediate basis for international trade

• What underlies relative price differentials?

• Some of the factors are:

➢ Resource endowments
➢ Technology
➢ Tastes & preferences
➢ Income levels.
 The Background

• In 1920s and 1930s , two Swedish

economists, namely E. Heckscher and B.
Ohlin formulated a theory to address two
questions not explained by Ricardo
• The questions are:
1) What determines comparative advantage?
2) What effects does international trade have on the
earnings of various factors of production
(distribution of income) in trading nations?
• The Factor Endowment Theory (also known
as Heckscher-Ohlin Theory) tires to answer
the above questions.
The Factor Endowment Theory

• The theory states that comparative advantage can be

explained by differences in relative national supply
conditions. Differences in factor supplies arise due to
disparities in natural endowments (climate, water, forest
resources, minerals etc.) and factor endowments (land,
labour, capital, entrepreneurial skills )

• It highlights the role of nation’s resource endowments (e.g.

labour, capital etc.) as the key determinant of comparative
advantage

• Examples: Brazil exports coffee (soil & climatic condition),

USA exports wheat (temperate-zone land), India exports
garments (abundant labour)
 Assumptions of the Theory

• Nations have same tastes and

preferences (identical demand
conditions)

• Factor inputs are of uniform quality

• Nations use same technology

Explanations for Price Differentials

• According to the H-O-Theory, relative

price levels differ among nations
because:

➢ Nations have different relative

endowments of factor inputs

➢ Different commodities require that the

factor inputs be used with differing
intensities in their production.
 Directions of International Trade

• A nation will export that commodity

for which a large amount of the
relatively abundant (cheap) input is
used

• It will import that commodity in the

production of which the relatively
scare (expensive) input is used.
An Evaluation of the H-O Theory
• An improvement over previous theories as it takes into
consideration more than one factor of production (labour and
capital), hence more realistic

• However, it continues to accept many assumptions of the

classical theories (e.g. similar production function among
countries, constant costs, absence of tariff, quotas & govt.
interference in trade etc.)

• It does not take into consideration the possibility of factor

reversals, that is, a situation when an originally labour-
intensive commodity might become a capital-intensive product
if relative prices of factors change

• Not all empirical tests (of this theory) support its predictions.
 Empirical Evidences

• First attempt to investigate the factor endowment theory was

undertaken by Wassily Leontief (1954)

• Leontief analyzed capital labour ratios for some 200 export

industries and import-competing industries in United States using
1947 trade data

• Hypothesis: U.S., being capital abundant and labour-scare country,

should export capital-intensive goods and its import-competing
industries should be labour-intensive

• Findings: Capital/ labour ratio in export industries ($ 14,000) was

lower than import-competing industries ($18,000). So exports
were less capital-intensive than import-competing goods.

• This findings which contradicted the predictions of the H-O-Theory

is known as Leontief Paradox.
 Empirical Evidences
• Critics pointed out that selection of the base
year led to this erroneous results. 1947 was
not a normal year because the World War II
reconstruction of the world economy had
not been corrected by that time

• To silence critics, Leontief repeated his

investigation in 1956 by analyzing 1951
trade data. But findings were similar.

• Many other studies have tested the

predictions of the H-O-Theory, but their
results are inconclusive.
 Empirical Evidences

• More recently, researchers have increasingly

focused on the importance of worker skills in the
creation of comparative advantage. Investments in
skill, education & training, which enhance a
worker’s productivity , create human capital in
much the same manner that investments in
machinery create physical capital. Example: USA
with abundant skilled labour force can produce and
export skill-intensive goods such as jetliners,
computer software etc.

• A study by the World Bank (1985) (that analyzed

export data for 126 industrial and developing
nations) found that nations endowed with relatively
large amounts of skilled workers tend to emphasize
the export of manufactures. In contrast, land-
abundant countries tend to emphasize exports of
primary goods.
 Factor Price Equalization

• The Theory was developed by Prof.

Samuelson in 1948

• This is an extension of the H-O Theory

• Accepting the H-O Theory, it says that if a

country increases the production of a
commodity using its abundant factor (say
labour), the demand for the abundant factor
will increase leading to an increase in its
price (e.g. wage).
 Factor Price Equalization
• The demand for the scare factor (say capital) will
decline bringing down its price (e.g. rent)

• Thus the prices of two factors tend to come

closer to each other, i.e. prices of factors
converge in the same country

• Opposite trends may develop in the other country

(trading partner) in regard to its abundant/
scarce factors

• This will tend equalize factor prices in the two

countries (second convergence).
Factor Price Equalization- An Example

• Let’s assume two countries (A & B) produce two

commodities (wheat & tractor) using two factors
of production (land & capital)

• Also country A is abundant in land and it

produces wheat; and country B, which is capital-
abundant, produces tractor

• If trade takes place between the countries, A will

buy tractors from country B (who will buy wheat
from A).
Factor Price Equalization- How it Works

• A’s buying tractor from B will raise price of tractors

and hence price of capital (it is capital-intensive
good) in country B

• But price of capital in country A will come down due

to its declining demand in that country

• Similarly, B’s buying of wheat from A will increase

price of land in A, while it’s (land) price will show a
declining tendency in the domestic market

• The operation of the market forces will tend to

equalize factor prices in A and in B.
 A Case towards Factor Price
Equalization

• The case is from the U.S. auto industry

• By early 1980s, the compensation of the
U.S. auto workers was roughly double that
of the Japanese auto workers
• A General Motor worker earned an av.
Hourly wage of $ 19.65, as against a
Japanese auto worker earning $10.70/
hour
• Due to recession and high fuel price in
U.S. demand for autos declined.
 A Case towards Factor Price
Equalization
• However, U.S. consumers continued to purchase Japanese
vehicles (due to lower costs)

• U.S. auto makers lost markets, this led to fear of job losses
among auto workers in U.S.

• To save its members’ jobs the United auto workers (UAW)

Union reluctantly accepted wage cuts, so that companies
remain in business

• The gap in wages between U.S. auto workers and

Japanese auto workers reduced

• Later UAW pushed for trade legislation to further restrict

forien autos entering the United States, thereby insulating
the wages of domestic auto workers from the market
pressure created by foreign competition
 Does it Happen in Reality?

• In the real world, differences in factor prices do exist. Av.

salary of unskilled workers are much higher in United States
as compared to India

• Existence of differences in factor prices are explained by the

fact that the assumptions underlying the theory are not
completely borne out in the real world. For example :
➢ Different countries use different technologies
➢ Markets are not perfectly competitive
➢ Transportation costs and trade barriers may prevent product
prices from becoming equal

• Such things reduce volume of trade, limiting the extent to

which commodity prices and factor prices can become equal.
New International Trade
Theories
These Theories are based on

1. Economies of Scale
2. Demand Conditions
3. Product Life-cycle
 Trade based on Economies of
Scale
• World trade patterns can also be explained by
Economies of Scale of large scale production

• Such economies of scale are pronounced in industries

that use mass-production techniques and capital
equipment

• The economic justification of economies of scale is

that a large organization may reduce costs by various
methods, such as:

➢ specializing in machinery and labour,

➢ operating assembly-line production using its by-
products; and
➢ obtaining quantity discounts on purchase of inputs.
 Economies of Scale as a source of
Comparative Advantage
• How do economies of scale underlie a nation’s
comparative advantage?

• The answer was given by Adam Smith in his 1776

classic, The Wealth of Nations

• It stated that division of labour is limited by the size of

the market. By widening the size of a firm’s market,
international trade permits the firm to take advantage of
longer production runs, which lead to increasing
efficiency

• Example: in recent years Boeing had sold half of its jet

planes overseas. Without exports, Boeing would have
found it difficult to cover the large design and tooling
costs of its jumbo jets; and jets might not have been
produced at all.
 Advantages of Trade

• Economies of scale provide additional cost

incentives for product specialization

• Instead of manufacturing only a few units of each

and every product that domestic consumers desire
to purchase, a country specializes in the
manufacture of large amounts of a limited number
of goods and trade them for remaining goods

• The countries can buy the goods produced at the

minimum (av.) cost

• Both countries gain (attain higher consumption

levels) by trading.
 Trade Influenced by Demand
Conditions
• The relationship between demand conditions and
international trade patterns was analyzed by
Staffan Linder (1961)

• According to Linder, the factor endowment theory

can largely explain the world trade patterns in
primary (natural resources) and agricultural
products, but not in manufactured goods

• Much of international trade involves

manufactured products , where demand
conditions play an important role.
 Theory of Overlapping
Demands
• The theory that was developed by Staffan Linder taking
demand conditions into consideration is known as
Theory of Overlapping Demands

• Linder stated that firms generally manufacture those

goods that have large domestic market

• This market determines the set of goods to be produced

when firms begin to export

• The foreign markets that have similar consumer tastes

and preferences have maximum export potential

• Thus a nation’s exports are an extension of the

domestic market.
 Theory of Overlapping
Demands
• Linder contends that consumers’ tastes depend on their income
levels (av. or per capita income)

• Nations with high per capita income will demand high quality
manufactured goods (luxuries), while nations with low per
capita income will demand low quality goods (necessities)

• Linder’s hypothesis helps to explain which types of countries

would like to trade with each other

• Nations with similar per capita income will have overlapping

demand structures and will likely consume similar types of
manufactured goods

• Wealthy (developed) nations will likely trade with wealthy

nations and poor (developing) nations with poor nations
 Relevance of the Theory
• Linder’s theory is in rough accordance with the reality

• A high proportion of international trade in manufactured goods

take place among relatively high income (industrial) countries
(e.g. between United States, Japan, Canada, European nations
etc)

• Much of this trade involves exchange of similar products

• Germans may buy home-grown BMW, but they might decide to

purchase Lexus from Japan or Volvo from Sweden based upon
their tastes and preferences

• The theory does not rule out all trade in manufactured goods
between wealthy nations and poor nations. Some people in
poor nations could be wealthy and hence there will be some
overlapping demand for manufactured products.
Product Life Cycle
Theory
 The Background
• The trade theory explained so far were based on the
assumption of a given and unchanging state of
technology

• The basis of trade was attributed to differences in:

➢ Labour productivities
➢ Factor endowments
➢ National demand structures

• In a dynamic world, however, technological changes

occur in different nations at different rates of speed

• Technological innovations result in new methods of

producing existing goods, in the production of new
goods or improvement in goods

• These factors can affect comparative advantage and

the pattern of trade.
 Product Life Cycle Theory

• The theory was developed by Raymond Vernon

(1966)

• It focuses on the role of technological innovation as

a key determinant of trade patterns in
manufactured products

• According to this theory, many manufactured

goods (e.g. electronic products) undergo a
predictable trade cycle

• During this cycle, the home country initially an

exporter, then loses its competitive advantage vis-
à-vis its trading partners, and eventually become
an importer of a commodity
 Product Life Cycles

Many manufactured products go

through the following stages:

I. The good is introduced to the home

market
II. Domestic industry shows export
strength
III. Foreign production begins
IV. Import competition begins
 Various Stages of the Product

• In the introduction stage, the innovator starts

production keeping an eye in the local market. The
market size does not permit mass-production

• The domestic manufacturer begins to export. The

market become large enough to support mass-
production (growth & expansion)

• The manufacturer realizes that it must locate

production operations closer to the foreign
markets to protect its export profits. The domestic
industry enters its mature stage as innovating
businesses establish branches abroad.
 Various Stages of the Product

• Over time the innovating nation may find its technology

becoming more commonplace and transportation costs and
tariffs playing an increasingly important role in influencing
selling costs

• The innovator also may also find that the foreign market is
large enough to permit mass-production

• The benefits of being monopoly (th. patents etc) of the

product cease to exist over time. Import competition from
foreign producers begins. Once the innovative technology
becomes a fairly commonplace, foreign producers begin to
imitate the production process

• The innovating nation gradually loses its comparative

advantage and its export cycle enters a declining phase.
 Trade Cycles

• The trade cycle is complete when the product

process becomes so standardized that it can be
easily used by other nations

• The technological breakthrough therefore no

longer benefits the innovating nation

• In extreme case, the innovating nation may even

become a net importer of the product

• Example: Textiles and paper products are

generally considered to have run the full course
of the trade cycle.
 International Product Cycle : The
Case of Pocket Calculator
• Pocket calculator has moved through
various stages of the international product
cycle

• The product was invented in 1961 by

engineers at Sunlock Comptometer Inc.

• It was soon marketed at a price of $1,000 a

piece (it was more accurate than slide rules
and more portable than large mechanical
calculators and computers).
 The Case of Pocket Calculator

• By 1970, several U.S. and Japanese

companies entered into the market (for
example: Texus Instruments, Hewlett-
Packard, Casio etc.)

• Over time some other producers also

entered into the market and several
companies began to assemble their
products in foreign countries, such as
Singapore and Taiwan (low labour costs)

• These calculators were then shipped to the

United states
 The Case of Pocket Calculator

• Technology improved steadily and it resulted in

product improvements and falling prices

• By mid-1970s, a pocket calculator was sold at a

price between $10 to $20 (even less)

• By late 1970s, the pocket calculators had reached

the standardized-product stage (technology was
available to every one, price competition prevailed)

• In a period of less than two decades, the

international product cycle for pocket calculators
was complete.
 4-28

Porter’s Diamond
(Harvard Business School, 1990)

• The Competitive Advantage of Nations.

• Looked at 100 industries in 10 nations.
– Thought existing theories didn’t go
far enough.
• Question: “Why does a nation achieve
international success in a particular
industry?”

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

 Comparative Advantage Vs.
Competitive Advantage
• Comparative Advantage corresponds to specific
factors for sourcing inputs and marketing outputs
such as relative factor costs, availability, price and
quality of products and the size, growth and
accessibility of markets.

• Competitive Advantage, on the other hand, is derived

from firm specific assets and it describes the
proprietary elements of the firm that distinguishes it
from its competitors.

• Comparative and competitive advantage are not

entirely independent concepts, as comparative
advantage of a nation may contribute to competitive
advantage of firms originating or located in that
country and vice-versa. 63
Porter’s View on Competitive
Advantage

“Whereas comparative advantage is

derived from the resource
endowment of the country and is
therefore external to the policy
system, the competitive advantage is
factor performance and technology
driven and thus alterable through
policy changes and managerial
action” (Porter, 1990).
64
 Determinants of National
Competitive Advantage

• Factor endowments:nation’s
position in factors of production
such as skilled labor or
infrastructure necessary to
compete in a given industry.

65
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 Determinants of National
Competitive Advantage

• Factor endowments:nation’s position in

factors of production such as skilled
labor or infrastructure necessary to
compete in a given industry.
• Demand conditions:the nature of home
demand for the industry’s product or
service.

66
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 Determinants of National
Competitive Advantage
• Factor endowments:nation’s position in
factors of production such as skilled labor
or infrastructure necessary to compete in
a given industry.
• Demand conditions:the nature of home
demand for the industry’s product or
service.
• Related and supporting industries:the
presence or absence in a nation of
67
supplier industries or related industries
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 Determinants of National
Competitive Advantage
• Factor endowments:nation’s position in factors
of production such as skilled labor or
infrastructure necessary to compete in a given
industry.
• Demand conditions:the nature of home
demand for the industry’s product or service.
• Related and supporting industries:the presence
or absence in a nation of supplier industries or
related industries that are nationally
competitive.
• Firm strategy, structure and rivalry:the
conditions in the nation governing how68
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 Porter’s Diamond 4-30

Determinants of National Competitive

Advantage

Firm Strategy,
Structure and
Rivalry

Factor Endowments Demand Conditions

Related and
Supporting
Figure 4.6
Industries

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

 4-31

The Diamond

• Success occurs where these attributes

exist.
– More/greater the attribute, the higher
chance of success.
• The diamond is mutually reinforcing.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

 National Competitive 4-32

Advantage

Chance
Company Strategy,
Structure,
and Rivalry

Two external
factors that Factor Demand
influence the Conditions Conditions
four
determinants.
Related
and Supporting
Industries
Government

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

 4-33

Factor Endowments
• Taken from Heckscher-Ohlin
• Basic factors:
– natural resources
– climate
– location
– demographics
• Advanced factors:
– communications
– skilled labor
– research
– technology
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 4-34

Advanced Factor
Endowments

• More likely to lead to

competitive advantage.
• Are the result of investment
by people, companies,
government.

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 4-35

Relationship of Basic to
Advanced Factors

• Basic can provide an initial

advantage.
• Must be supported by advanced
factors to maintain success.
• No basics, then must invest in
advanced factors.

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 4-36

Demand Conditions

• Demand creates the

capabilities.
• Look for sophisticated and
demanding consumers.
– impacts quality and
innovation.

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 Related and Supporting 4-37

Industries

• Creates clusters of supporting industries

that are internationally competitive.
• Must also meet requirements of other
parts of the Diamond.

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 4-38

Firm Strategy, Structure

and Rivalry

• Management ‘ideology’ can either

help or hurt you.
• Presence of domestic rivalry
improves a company’s
competitiveness.

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 4-39

Evaluating Porter’s Theory

• If Porter is right, we would expect his

model to predict the pattern of
international trade that we observe in
the real world. Countries should be
exporting products from those
industries where all four components of
the diamond are favorable, while
importing in those areas where the
components are not favorable.
• Too soon to tell.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
 Implications for
Business
• Location implications:makes sense to
disperse production activities to countries
where they can be performed most
efficiently.
• First-mover implications:It pays to invest
substantial financial resources in building
a first-mover, or early-mover, advantage.
• Policy implications:promoting free trade is
generally in the best interests of the
home-country, although not always in the
best interests of the firm. Even though, 79
many firms promote open markets.
Evaluating Porter’s Model
• Porter’s model triggered a wave of debate
on the subject.
• Many appreciated Porter’s diamond
model for providing a broad
framework that combines strategic
management and international
economics to explain the competitive
advantage of nations.
• The critics, however, cited the model
as a set of theoretical 80
 Evaluating Porter’s Model

• The model is more suited for more

advanced countries and it lacked
applicability in smaller or developing
economies (Rugman, 1991) .
• Porter did not appropriately consider the
forces of globalization and multinationals
The dynamic interplay of the
multinationals in various countries can
affect the competitiveness of such
countries. But by assigning no role to
multinationals, an important aspect of
competitiveness was ignored. (Dunning,
81
1992 1993).
 Evaluating Porter’s Model
• Dynamic influences of a few important
factors such as technology, international
business, labour costs, and exchange rates
on international competitiveness were not
duly considered by Porter’s model (Narula
& Daly, 1993).
• The government should be given a more
prominent role than has been assigned by
the Porter’s model (De Man, 1994).
• Davies and Ellis (2000) described Porter’s
analysis as “hopelessly rich but gloriously
wrong”. 82
 Evaluating Porter’s Model

• In spite of certain shortcomings of the

Diamond Model, Porter’s contribution in
the competitiveness theory cannot be
undermined. In fact, following Michel
Porter’s work, the subject of
competitiveness has been receiving
increasing attention of the economists,
management scholars and the policy
makers. The large number of works that
have come into existence from 1990s on
the areas of national, regional, industry
83
and firm competitiveness proves this
Thank You

84