The Concept of The New Trade Theories - Essay Example

?A Discussion of Competitiveness of Locations Using Trade Theory This essay sets out to consider how trade theory informs how competitive different locations are in a globalised trading environment. It begins by setting out the new trade theories of economies of scale, demand-led growth, the product life cycle, monopolistic competition and the theories of Paul Krugman. These theories are then examined within the context of global trade locations to determine whether the competitiveness of different locations can be explained by trade theory alone, or whether other influences should be taken into account. The essay concludes with a brief summary of the findings of the discussion. New Trade Theories The new trade theories address the area of competitive strategy in various ways, usually (but not always) relating to globalisation. Sloman (2005 p.307) identifies the following as reasons for organisations to expand beyond their home nation: access to new markets, new customers, new supply sources and new ideas and skills. They also have to deal with competition within their home nation from overseas organisations who can produce goods at a lower cost or with some innovative function or features. One of the main reasons organisations go overseas is to reduce their overall costs. Sloman (2005 pp.310-311) identifies the following as areas within which costs can be reduced by setting up operations overseas: Resource costs, including labour Skills held by workers, including entrepreneurial and management skills Cost reductions as a result of the learning curve Economies of scale Transport costs Government policies. Many of these areas are addressed by new trade theories. Economies of Scale Economies of scale result from increasing production capacity to reduce the overall costs of production. Lynch (2009 p.801) defines them as “the extra cost savings that occur when higher-volume production allows unit costs to be reduced”. Production costs can be lower in countries other than the home nation, such that producing goods in those countries and then importing them to the home nation actually costs less than producing them in the home nation. This also allows low cost supplies to be imported to countries other than the home nation, for the same cost of production, with the only differences being costs of transport and import duties and taxes. The presence of economies of scale can prevent new competitors entering the market if they involve large-scale production facilities or very specialised facilities requiring significant capital investment to replicate. Demand-Led Growth Setterfield (2003, p.25) identifies a counterpoint to the focus on supply-side driven growth in the form of demand-led growth. He outlines two effects on growth rates stemming from the demand-side of the growth equation: the potential for demand failures in the long run, and the impact of demand conditions on productive resources over time. The theory states that “there is no supply-determined equilibrium” (ibid) for output levels. Instead output levels are determined by relatively autonomous demand conditions coupled with supply-side conditions. Setterfield (2005, p.26) says that “the sequence of short-run outcomes associated with the demand-determined utilisation of productive resources traces out the economy’s long-run growth path” and does not automatically to the output path of the economy. He further points out that “the potential growth rate of the economy depends on the growth of physical capacity, labour resources and factor productivity” but that “each of these is affected by the demand-determined actual rate of growth” (ibid). In short, demand-led growth requires attention to be paid to the demand side of the supply = demand equation. The Product Life-Cycle Every product has a life-cycle, starting with growth and ending with decline and obsolescence: Figure 1: The stages in a product’s life cycle (Source: Sloman, 2005, p.313) When considering the global situation, launch would normally take place in the country where the product is developed. During the growth phase, with increasing competition in the home market, opportunities to produce the product in a lower-cost economy might be sought. Thus far the product will only have been released in the developed world. At maturity, production might move to other developed countries or look to set up production in countries that are earlier in the development cycle. The original market will eventually reach saturation point, and the product allowed to either decline to obsolescence, or rejuvenated using new add-on capabilities or good marketing. The need to reduce costs will cause the manufacturer to seek the lowest possible production costs and production might move again to achieve this. Monopolistic Competition Sloman (2005 p.105) defines monopolistic competition as “a market structure where, like perfect competition, there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price”. As perfect competition is impossible to achieve, monopolistic competition is the best that can be hoped for in any market. However, with monopolistic competition, as the organisation has some influence over the price of the product or service, organisations can be seen to set prices higher than necessary, benefiting themselves at the expense of the consumer. This is currently the case with organisations supplying power to homes and industry (see Treanor 2010). The Theories of Paul Krugman Paul Krugman has presented findings on several areas of economic theory, including “the effects of trade on firm scale and product diversity in a general model of monopolistic competition; the integration of monopolistic competition with factor endowments theory; the implications of transport costs, including home-market effects and the possibility of agglomeration in models of economic geography; and the positive and normative consequences of oligopolistic trade” (Neary, 2009, p.217). It was for his work in the area of trade patterns and location of economic activity that he won the Nobel Prize in 2008. Krugman’s first paper was published in 1979 with two other key papers following in 1980 and 1991 (Brakman and Garretsen 2009). Krugman’s ideas included treating large regions as closed systems, within which certain accounting relationships must hold true within the prevailing international financial system (Moss, 2009, p.157). He advocated free trade and eschewed protectionism. Problems with Free Trade Theory Since Krugman’s initial writings, other commentators have identified problems with the free trade doctrine, finding that there are issues that were not considered at the time Krugman wrote. Krugman, for example, in 1994, commented that competitiveness did not matter in free trade, as it was raising domestic productivity that increased living standards. The following year, another author, John Dunning, countered Krugman’s view, indicating that competitiveness mattered because it provided a means for organisations and companies to benchmark themselves against the best and use that information to improve performance. Dunning (1995) takes issue with Krugman’s expressed view, pointing out that six conditions must exist before Krugman’s argument holds (pp.317-318). The focus is on comparative advantage, ignoring the effects of economies of scale and innovation, and ignore the costs of market adjustments when supply or demand conditions change (ibid, p.318). Dunning argues that allowing for such things makes competitive benchmarking useful to organisations and countries who are looking to improve. Krugman connected the worlds of international trade, economics and geography with his work, especially his 1991 paper, “Increasing Returns and Economic Geography”. This paper advocated a country becoming differentiated with an industrialised core and agricultural periphery. The emphasis is on manufacturing. Manufacturing firms locate in larger demand areas, but such demand depends on the location of manufacturing firms. Krugman (1991, p. 483) focuses on transportation costs, economies of scale and the share national income attributable to manufacturing, as determining the core-periphery pattern emergence. In 2000, he went on to provide a context that allowed the discussion of one part of a country as part of the whole (he gives the example of discussing New York’s economy within the context of the US economy – Krugman, 2000 p.50). He also takes time to deal with an objection raised by Dunning as to the immovability of resources, pointing out that workers, for example, need to be near the sources of consumer goods (ibid, p.54). This does not, however, take account of changes in information and communication technology that allows individuals to work from home anywhere in the world, downloading work from their employer who could be based in another country. Krugman identifies that for a geographical concentration of particular industries to occur, a vertical structure of production is required, “in which one or more upstream sectors produce inputs for one or more downstream sectors – and in which both upstream and downstream producers are subject to increasing returns and transport costs” (ibid, p.55). The linkages between the different producers, whether upstream or downstream tend to concentrate all producers in a single location. Producers locate in the location where both upstream and downstream industry are located. These arguments do not stand up to scrutiny when considering global supply chains and locations of facilities. Krajewski and Ritzman (2005, p.395) describe the purpose of supply chain management as seeking “to design a firm’s customer relationship, order fulfilment and supplier relationship processes and to synchronise these processes with the key processes of its suppliers and customers in order to match the flow of services, materials, and information with customer demand”, which would seem to tie in with a demand-led approach, rather than a pure supply side one. Transporting products, whether raw materials, work in progress or finished goods, falls within the supply chain of an organisation which manufactures goods. Krugman tends to separate the different elements that an organisation needs to integrate if it is to achieve an integrated supply chain, especially if that supply chain is global. Lubowe (2009, p.22) has devised a framework for operationalising global integration of supply chains, the R-O-I framework, which identifies three elements that must be addressed concurrently: repeatable processes, optimised assets and integrated operations. His research revealed “a set of clear, replicable strategies for operationalising global integration” (ibid). He found a holistic approach to operations and supply chain management was essential to achieve “truly globally integrated operations” (ibid p.23). As such, an organisation looking to locate facilities cannot ignore factors that fall outside of Krugman’s ideas, which focus primarily on the economics and the political economics of facility location. Does Location Make a Difference: an Analysis To assess whether location makes a difference, figures have been obtained for the import and export of textiles in their raw, basic manufactures and miscellaneous manufactured goods state for the world regions and countries within those regions. These figures will be analysed to determine whether location confers any advantage and, if so, what type of advantage it is. Figures are provided by Euromonitor International, using an academic subscription service to the Global Market Information Database (GMID), and are not available to the general public – see www.euromonitor.com. The world regions and countries selected are as follows: World Region Selected Countries Asia Pacific China, India Australasia Australia Eastern Europe Hungary, Russia Latin America Argentina, Brazil Middle East and Africa Egypt, Kuwait, Saudi Arabia, South Africa North America Canada, USA Western Europe France, Germany, United Kingdom Table 1: Selected Countries/Regions for Analysis Country Category of Export Textile Fibres and Their Wastes Textile Yarn, Fabrics, Made-Up Articles Articles of Apparel and Clothing Accessories (US $ mn) (US $ mn) (US $ mn) China 1,540.1 59.665.0 105.979.8 India 1,409.1 8.500.2 11,200.7 Australia 1,915.5 243.4 183.0 Hungary 38.7 431.5 620.8 Russia 29.1 276.7 105.2 Argentina 170.0 213.7 93.1 Brazil 809.1 953.3 172.9 Egypt 169.4 768.3 725.6 Kuwait 20.9 7.6 10.8 Saudi Arabia 10.4 68.0 32.1 South Africa 308.3 263.3 117.2 Canada 191.8 1,630.4 996.7 USA 5,274.2 9,908.3 4,177.1 France 397.8 5,867.3 10,452.1 Germany 1,288.5 12,021.5 16,396.8 United Kingdom 702.1 3,518.2 5,326.9 Table 2: Textile Export Categories by Country for 2009 To provide a framework within which to analyse this data, Porter’s (1990) Diamond of Competitive Advantage will be used. Figure 2: Porter’s Diamond of Competitive Advantage (Source: Porter, 1990, p.77) Porter (1990) analysed competition and identified four inter-related factors that determined a nation’s ability to compete. The Diamond of Competitive Advantage considers factor conditions, firm strategy structure and rivalry, demand conditions and related and supporting industries to be key influences on national competitiveness. Factor conditions relates to the country’s access to the factors of production – land, labour and capital – together with highly specialised resources that can only be found in that country and confer a competitive advantage. Demand conditions are those in the organisation’s home nation. Related and supporting industries are the providers of activities associated with the industry being assessed, without which the industry cannot survive. Firm strategy, structure and rivalry are the internal elements of the firm over which the organisation has control and which can be configured to take advantage of markets and opportunities. Demand conditions and related and supporting industries within each country cannot be determined unless a full analysis of each country is conducted, which is beyond the scope of this paper. Equally, it is not practical nor feasible to conduct a survey of each country’s organisations to determine their strategies, structures and rivalries. However, as factor conditions can relate to geographic location, and as figures for area, population numbers, density and literacy are available, these will be used as a proxy for assessing the factor conditions of the countries selected. Factor Endowments Country Factor Condition Area Population Population Density Adult Literacy (km2) (000s) (people/ km2) % China 9,597,000 1,331,219.0 138.7 94.0 India 3,166,830 1,176,813.5 371.6 67.7 Australia 7,682,300 21,948.3 2.9 99.9 Hungary 93,030 10,009.7 107.6 98.9 Russia 17,075,400 141,844.9 8.3 99.6 Argentina 2,777,815 40,471.1 14.6 97.8 Brazil 8,511,965 194,578.5 22.9 91.9 Egypt 997,739 88,460.8 77.6 73.6 Kuwait 17,280 2,471.9 143.0 94.7 Saudi Arabia 2,149,690 25,983.3 12.1 85.7 South Africa 1,219,912 50,301.1 41.2 88.9 Canada 9,922,385 33,809.4 3.4 99.7 USA 9,363,130 307.731.3 32.9 99.9 France 543,965 62,610.5 115.1 99.0 Germany 356,840 81,861.9 229.4 99.9 United Kingdom 244,755 61,789.0 252.5 99.8 Based on this information, it seems clear why the world is currently concerned about the influence of China in global markets. With a large population, large land mass and a fairly literate workforce, the factor conditions appear to be present and not being utilised as well as they could be, compared to India, where the population is almost the same, but the land mass about one third the size. India’s workforce appears to be the least literate of this group of countries, but this disguises a wide disparity between the extreme poor, who are unlikely to have many literacy skills at all, and the computer graduates who complete programming tasks for the West and therefore have a very high degree of literacy. Russia has the largest land mass, with the potential for discovery of minerals and crude oil, however, much of the land is uninhabitable, restricting the degree to which Russia can exploit its potential. The most interesting country is Germany, with a relatively small land mass, high population density and high literacy, generating the fifth highest value of exports of textile fibres and their wastes, and is second only to China (where there is a huge gap) in exports of textile yarn, fabrics and made up articles, and articles of apparel and clothing accessories. Clearly Germany is leveraging its resources to generate substantial exports, gaining a comparative advantage over many of the world’s nations in these areas, and probably the highest value of exports in Western Europe. The USA has almost the same land mass as China, with about a fifth the size of population, yet even with its far more advanced development, cannot generate the same exports in percentage terms as China. The comparative percentages for the USA relative to China are: 97.6% land mass 23% population 342.5% exports of textile fibres and their wastes 16.6% of textile yarn, fabrics, made-up articles 3.9% of articles of apparel and clothing accessories. Literacy levels are comparable at 99.9% (USA and 94% (China), yet it is clear that China has a comparative advantage in two of the three areas being considered, meaning China is leveraging its higher population and skills base to generate far higher export values. If it is assumed that the USA produces raw materials, which are exported, these might be imported by China for the next stage of the process (manufacturing) before being exported back to the USA as finished goods. Another possibility is that China imports work-in-progress and adds the final touches to garments, before exporting these to retailers for sale to consumers. The costs of manufacturing and augmentation are clearly lower in China than in the USA, which is why the Chinese produce so much of the finished goods market. China would seem to have both comparable and absolute advantages over the USA in the finished goods aspect, but the USA has a comparable and absolute advantage in the raw materials aspect. The worry for the USA is that China have not reached their full production potential, and are still able to generate these levels of export: if they continue with this degree of leverage, then they will become the dominant player in these markets, which extrapolated to global markets overall, means China will become the dominant global supplier of goods and services. So it is clear that location does confer some advantages. But what these figures do not reveal, and what is not accounted for in free trade theory, are the consequences of these levels of trading for those involved. China can afford to produce goods more cheaply than other nations because their workforce are paid comparatively less than their equivalents in the West, and working conditions are reportedly extremely poor. No account is taken of the effect on the environment of intensive industry activity, and resources are finite (especially minerals and crude oil, although those are not considered here). Free trade certainly sounds like a good idea, but it appears to benefit the few at the expense of the many (although China, India and Russia may change that in the near future). Whether such trading patterns can be continued, or indeed whether the levels of consumption they represent can be justified, is another matter. Conclusion Krugman’s ideas around free trade are focused exclusively on the economics, without taking any account of other factors that influence location of facilities. There are important elements that affect how competitive an organisation is, especially in a global arena, which Krugman discounts as, for him, competitiveness is not relevant to location. Krugman’s research also has a very pro-USA stance, which is not necessary relevant nor effective in other countries, even those culturally similar to the USA. For the developing world, Krugman’s ideas could be perceived as exploitative. Certainly Krugman never questions the morality or ethics of using locations overseas because of their comparatively cheap labour. Overall, Krugman’s ideas provide some idea of why firms locate in particular areas, but they ignore changes in information technology and the increasing interest in ethical debates, such as worker exploitation and sustainability. They should therefore not be taken in isolation, but considered as part of a full review of facility location and supply chain management strategy. 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