Transcript Theory of Competitive Advantage

Theory of Competitive Advantage
• From the Diamond model to Industry Clusters:
– Each determinant of the diamond model significantly
affects the other and therefore jointly impacts the
competitive advantage of industries.
– E.g a group of rivals will stimulate the development of
a pool of skilled labour, extend and upgrade home
demand by attracting more firms and create an
attentive base of specialised suppliers.
– The intensity of interactions within the Diamond is
reinforced by the geographic proximity or the
clustering of the firms and institutions within the
particular sector. Clusters occur because proximity
reinforces interaction between the actors of the
system and consequently the benefits of this
interaction are intensified.
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Theory of Competitive Advantage
• From the Diamond model to Industry Clusters:
– Therefore, the focus of clusters is not solely on the
agglomeration of a single industry but on the external
economies that are achieved from having a group of
domestic rivals that serve demanding customers, are
surrounded by specialist suppliers and related
industries and have access to local knowledge
institutions.
– Note: External economies occur outside a firm, within
in an industry, when an industry’s scope of operations
expands due to, for example, the creation of a better
transportation network, resulting in a subsequent
decrease in cost for a company working within that
industry. With external economies all firms within the
industry benefit. According to Porter firms in industry
clusters can benefit from external economies
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Theory of Competitive Advantage
• Such external economies are assumed to increase the
productivity level of individual firms and their capacity for
innovation thus providing them with a competitive
advantage.
• In addition, a cluster is perceived as an important
stimulant for new businesses, as the existence of
external economies attracts firms to an area where
resources are easily accessed and better information on
opportunities is readily available.
• Porter defines a cluster as:
“Clusters are geographic concentrations of interconnected
companies, specialized suppliers, service providers, firms in
related industries; and associated institutions (e.g. universities,
standards agencies and trade associations) in particular fields
that compete but also co-operate” (Porter)
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Theory of Competitive Advantage
• Porter’s thesis: if these industry clusters
develop in a nation then a nation will
have a competitive advantage over
other nations in these particular
industries/sectors
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• Porter’s theory of the competitive advantage of
nations focuses on the role of the home nation
• Porter: industry clusters – which are the
interaction of the four elements of the Diamond
model creating a group of firms within the same
or related industries located in close
geographical proximity– give a nation a
competitive advantage in particular sectors
• The four elements of the model are driven by
home conditions – home factors, home demand,
home suppliers/support, home rivalry
• How applicable is this theory for a small, open
economy?
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• The openness of such economies implies that
the local environment may have limited impact
on the competitiveness of firms
• Home demand conditions (i.e. presence of
demanding customers in the home nation): in a
small, open economy the domestic market is too
small/restricted for firms to serve. These firms
are export-driven
– In Ireland, particularly in the high-technology sectors,
many companies serve foreign markets i.e. their
customers are based abroad
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• Home suppliers/supporting industries
(presence of sophisticated
suppliers/supporting industries):
– in a small, open economy the domestic market is too
small for the development of a sophisticated supplier
base
– In applying Porter’s (1990) Diamond model to the
indigenous software industry in Ireland O’Gorman et
al. (1997) reported that most of the companies do not
have suppliers within the country
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• Home rivalry (presence of intense competition in
the home environment):
– A very open economy faces more intense competition
in foreign markets, which they are serving, than in the
local market. The local market is small – so most of
their competition/rivals are based abroad)
– In applying Porter’s (1990) Diamond model to the
indigenous software industry in Ireland O’Gorman et
al. (1997) reported that more than two thirds of firms
do not have many competitors based in Ireland or find
that foreign competition is more important for driving
innovation.
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• Foreign-owned firms:
– Porter places a very strong emphasis on
indigenous firms as the driving force of
competitiveness of particular industries within a
nation.
– According to Porter inward investment is thought
of as “not entirely healthy” and is “never the
solution to a nation’s competitive problems”.
– While in a later publication Porter (1998) does
acknowledge that clusters can and often do
include foreign companies, the role they play in
the host nation is left unexplained.
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A critical assessment of Porter’s theory
for a small, open economy like Ireland
• Foreign-owned firms:
– Ireland has a large foreign-owned sector that has
contributed to economic growth, however, it is
unclear according to Porter’s theory what role this
sector plays in the competitiveness of the nation.
• In Ireland, the concept of industry clusters
was embraced under a review of Irish
industrial policy in 1992, called the Culliton
Report
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Industry Clusters in Ireland
• Irish industrial policy and industry clusters:
– Inspired by Michael Porter, the Culltion Report (1992)
argued that industrial policy should work to create a
national competitive advantage around specific
clusters of related activities
– In response, IDA Ireland (Industrial Development
Authority) attracted large multinational corporations to
Ireland in specific sectors and enticed them to set up
in particular locations
– For example, the Irish medical device sector is driven
mainly by Boston Scientific and Medtronic, and is
primarily located in the West of Ireland
– Over 70% of software companies in Ireland are
located in the greater Dublin region
– The majority of pharmaceutical firms are based in
Cork
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Topic 1
• What we will cover
Topic 1: International Trade Theory and Policy
a. Interdependence and the gains from trade:
production possibilities frontier, Theory of
Comparative Advantage
b. Theory of Competitive Advantage
c. The Instruments of Trade Policy
d. Arguments for protection
e. Benefits of trade
f. GATT, WTO
g. EU: Free Trade Area, Customs Union
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The Instruments of Trade
Policy
• Source: “International Economics: A
European Focus”, Barbara Ingham (available
in the library)
Chapter 4: Theory of Trade Protection
– Free trade versus protection: one of the most
important issues in international economics
– Theory states that protection will reduce efficiency
and therefore constrain economic growth
– But not everyone, not even economists, agree that
there should be no trade protection
– We will go through the different instruments of
trade policy or types of protectionism, then we will
examine the arguments for protection and the
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benefits of trade
The Instruments of Trade
Policy
• Countries use a variety of measures, which
come under the heading of ‘trade protection’
• Main instruments of trade policy:
Tariffs or customs duties
– A tariff is a tax imposed on the import or export of a
good or service that crosses a national boundary
– Tariffs can take a number of forms:
– Specific tariffs: imposed as a fixed amount per unit of
import or export e.g. €1 per bottle of wine or €10 per
ton of coal imported. Specific tariffs are easy to collect
– they depend only on the number of items or the
volume of a product but they do not reflect the value
of the imports or exports
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The Instruments of Trade
Policy
• Main instruments of trade policy:
Tariffs and customs duties
– An ad valorem tariff relates to the total value of a
commodity imported or exported. For example, an
item valued at €100 could have 10%, i.e. €10
levied as an import or export duty (10% of the
monetary value of the product)
– Compound tariffs are a combination of specific
and ad valorem tariffs
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The Instruments of Trade Policy
• Main instruments of trade policy:
Tariffs and customs duties
– Another tariff-related concept: tariff escalation: this
means that tariffs are applied at a low rate on raw
materials, rising on semi-processed goods, and
highest of all on finished products
– Tariff escalation operates in the interests of domestic
manufacturing
– Raw materials are allowed into the country with low or
zero protection, intermediate goods attract some
protection, highest rates reserved for the final goods
– Effect: to concentrate protection on the final stages of
manufacturing. It discourages value-added
processing in the countries from which the raw
materials originate
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The Instruments of Trade Policy
• Main instruments of trade policy:
Non-tariff barriers:
– As tariffs have declined in importance, non-tariff
barriers have increased
– Non-tariff barriers are now the main obstacles to
free trade in the international economy
– Types of non-tariff barriers:
– Import quotas: limit the number of units of a good
or service that can enter an economy
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The Instruments of Trade Policy
• Main instruments of trade policy:
Non-tariff barriers:
– Import quotas can be imposed unilaterally (by one
country) or mulitalterally (by a number of
countries. Imposed by the importing country to
reduce supplies of foreign goods
– Export quotas: are imposed by an exporting
country for one of two reasons: 1. there is a wish
to manipulate the world price by restricting supply,
or 2. imposed to prevent exports of ‘strategic’
goods e.g. military hardware, strategic raw
materials (e.g. uranium)
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The Instruments of Trade Policy
• Main instruments of trade policy:
Non-tariff barriers:
– Like tariffs, quotas are straightforward and their trade
restricting intent is clear
– Two other types of non-tariff barriers are less
transparent: voluntary export restraints and subsidies
– Voluntary export restraints: these are quotas imposed
by the exporting country. But the word ‘voluntary’ is
misleading because the exporting country curtails
exports in order to forestall other trade restrictions
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The Instruments of Trade Policy
• Main instruments of trade policy:
Non-tariff barriers:
– Example of a voluntary export restraint: In 1981
Japan imposed a voluntary export restraint on its
exports of cars to the US. However, if Japan had
not set up the restraint, the US would have put a
quota on imports of Japanese cars
– Export subsidy: is a government payment to a
firm, which sells its products abroad. It can be
specific (a fixed sum) or ad valorem (a proportion
of the value of goods and services exported)
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The Instruments of Trade Policy
• Main instruments of trade policy:
Non-tariff barriers:
– Export subsidy: affects income distribution and
distorts markets. Producers receive large benefits
at the expense of the taxpayer. The Common
Agricultural Policy (CAP) of the EU is the best
known subsidy
Other policies in restraint of trade:
– Not all policies – which turn out to have
protectionist effects – are designed to be in
restraint of trade. Protective effects are unintended
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The Instruments of Trade
Policy
• Main instruments of trade policy:
Other policies in restraint of trade:
– Government procurement: government purchases
of goods and services – government could get
preferential prices, have domestic content
requirements and have a lack of competitive
tendering. All of these measures discriminate in
favour of domestic firms. The Government
Procurement Agreement (GPA) – negotiated under
GATT and it extends free trade principles of nondiscrimination to government procurement
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The Instruments of Trade Policy
• Main instruments of trade policy:
Other policies in restraint of trade:
– Marketing and packaging standards: can
discriminate against imports e.g. the
requirement that soft drinks be supplied in
returnable bottles discriminates against
importers in favour of domestic suppliers
(i.e. get 5 cent if you return a bottle)
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Arguments for Protection
• The Infant Industry
– The infant industry: the idea is to introduce a tariff on
a temporary basis
– The infant industry can grow up behind this tariff wall
– As the infant industry gains experience (learning by
doing) its costs will fall
– Eventually it will have a comparative advantage and
will be able to compete in the international economy
without the need for tariff protection
– The argument for infant industry protection needs to
be constructed with great care
– The argument for protection cannot be allowed to
depend on the realisation of the firm’s internal
economies of scale. This is because the firm should
be able to borrow against future profits that will tie
them over the early years when losses may be made
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Arguments for Protection
• The Infant Industry:
– However, if future benefits are external to the firm and
cannot be reaped by the individual firm then there may
be a case for protection. E.g. an infant firm may acquire
new knowledge which cannot be kept a secret but is
shared with all firms in the industry or the firm may train
workers in the particular field that will benefit other
firms, then social benefits outweigh private benefits. In
these circumstances a direct subsidy could be given to
the firm in compensation for the generation of new
knowledge or the training of labour. The subsidy acts to
stimulate the new industry in the region.
– The existence of external economies, therefore, can be
used to justify trade protection
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Arguments for Protection
• Non-economic arguments:
– Distribution of income: A tariff might be justified on the
grounds that it favours what would otherwise be a
disadvantaged group. For example, workers in a
particular industry, people living in certain regions,
farmers, the poor. Economists, however, respond by
stating that the distribution of income is better
managed with taxes and transfer payments
– Security and defence: imposing tariffs as a matter of
national defence or security. E.g. In 1950s/1960s the
US imposed restrictions on oil imports on the grounds
that a thriving domestic oil industry was a strategic
necessity
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