Extent to Which Factor Availability Does Not Explain the Competitiveness of Regions - Essay Example

?Discuss the extent to which factor availability is no longer an effective explanation of the competitiveness of regions or countries Instructor Introduction 3 Competitiveness Defined 3 Different Perspectives on Competitiveness 4 Domestic CPs 5 Perfect Competition Defined 6 The Four Assumptions of Perfect Competition 7 The Mathematical Elements of Perfect Competition 9 Critics Citing the Existence of Perfect Competition 10 Critics Citing the Unrealism of Perfect Competition 11 The Neoclassical Theory of Competition 12 Citing the Role of Factor Availability in Perfect Competition 13 Maki: the Unrealism of Perfect Competition 14 Free Trade Theory 15 Porter and other critics on the need for factor availability 16 Conclusion 17 Reference List 19 Introduction In the recent years, the term competitiveness has been used commonly, and sometimes has been abused. Looking at competitiveness from a bird’s eye view, one can deduce that the issues which form the core of competitiveness and are the hotbed of debates for economists and theorists are the same which have been the center of debate for the past centuries. The essence of competitiveness and allied issues is to gain an insight into the economical wellbeing of the country and the effective allocation of resources. This paper concerns with the factors that drive regional competitiveness, and whether factor availability is a contributing factor to regional competitiveness in the modern era or not. The essay looks into the concepts of competitiveness and perfect competition from a microeconomics perspective. Considering the factors that influence competitiveness at the level of the firms, one can establish that competitiveness depends on the capacity of the firms to compete, progress and to make profits (Martin n.d.). Competitiveness Defined Competitiveness is present in the potential of the firm to make products on a regular basis which fulfill the criterion of open market with respect to price and quality amongst other factors. Moreover, it also relates to the competence of the firms in making products that are profitable. Competitiveness at a microeconomics level buttresses the notion that for a firm that fulfills the criterion of an open market, it needs to be more competitive than other firms in order to capture a share of the market. Likewise, a firm that is not competitive will not be able to sustain a large market share and over the period of time, it will be forced out of the business unless it is supported by some artificial protection (Martin n.d.). When considering competitiveness between regions, one has to look beyond the competitive and noncompetitive firms, and to include the common traits of competitiveness present between regions. According to the Sixth Periodical Report on the Regions, regional competitiveness can be defined as the “the ability to produce goods and services which meet the test of international markets, while at the same time maintaining high and sustainable levels of income or, more generally, the ability of (regions) to generate, while being exposed to external competition, relatively high income and employment levels” (Martin n.d.). Different Perspectives on Competitiveness The notion of competitiveness of the national level is much more debatable and ambiguous. Although policy makers consider the attainment of competitiveness with respect to other firms as the main goal of the economic policy, competitiveness has been severely criticized and has been considered to be primarily “meaningless” (Martin n.d.); in fact, P Krugman, in his book Pop Internationalism, states that national competitiveness is a risky mania and has a vague macho ring to it (Krugman 1996). He argues that it is not correct to make a comparison between firms and countries because firms can be forced out of business if they are uncompetitive, but the same trend does not apply to countries. At the level of the firms, gaining market share affects other firms in the industry negatively, but on the regional or national level, the success of a country renders in the development of more opportunities for other countries rather than eradication; trade amongst countries is also not regarded to be a “zero-sum game” (Martin n.d.). P Krugman is also of the perspective that competitiveness between countries is an alternative terminology for productivity; an improvement in the living conditions of the citizens is achieved through a rise in productivity. Competitiveness can be considered from two different angles: as an aggregate of the competitiveness of firms or as a derivative of macroeconomic competitiveness (Martin n.d.). From the perspective of firms, it is the productivity of the region and its subsequent translation into higher wages and greater profits, leading to economic prosperity that makes a region competitive. On the other hand, the argument is not as simple at the macroeconomic level. There are certain laws and regulations that impact the dynamics of international trade, yet they are not present at the sub-national level. Conversely, migration between regions of mobile factors, capital and labor can prove to be a danger to the regions. Martin (n.d.) argues that if such macro-economic adjustment systems do not operate, the notion of macro-economic competitiveness cannot be implemented on the regional level. There are different theories that have been developed to understand the concept of regional competitiveness, and can be instrumental in analyzing if factor availability is crucial to the development of regional competitiveness of not. These theories include classical theory, neoclassical theory, Keynesian economic theory, development economics, new economic growth theory or the endogenous theory and the new trade theory (Martin n.d.). Domestic CPs An issue of great importance in the making of economic policies is domestic competition policies (CPs). Domestic CPs entails the take of the government on the competition that exists between firms, and how can it be used to promote economic growth in the country. It also includes the steps that the government takes in order to enforce these policies. Domestic competition policies are crucial to developing countries, since they are still struggling to maintain stability in their economic and political structure as compared to their first-world counterparts. Competition policies are aimed to impact the level of competition that is present in various industries such as food and textile. Considering them from this perspective, competition policies appear to be the “part and parcel” of a relatively broader class encompassing supply-side and industrial policies (Wignaraja 2003). Many economic theories hold that competition between different companies can be a very effective way of influencing their performance and productivity. Perfect Competition Defined The most crucial decisions that firms have to make are regarding profitability. This means that how much the firm produces and what profit it makes from its products are the two prime determinants of profitability (Thomas & Maurice 2008). Economic theories state that the nature of the price and decisions regarding the product are greatly impacted by the nature of the markets that the firms operate in. It is the structure of the market that decides whether the firm is going to be a price-setter or a price taker. The theoretical market structure that is characteristic of firms that take the price is referred to as perfect competition. It is argued that perfect competition can be a market structure where factor availability can be of no consequence to regional competitiveness; that is, regional competitiveness is not affected by the availability of factors. The core assumption of perfect competition is that the firms do not have any control over the price of the product. In a market, the type of competition that exists depends on whether or not product differentiation is present in the market as well as the number of firms operating in the industry. Another important determinant of the type of competition is the ability of one or all the firms in the industry to impact the market price (Mastrianna 2010). The Four Assumptions of Perfect Competition There are four main assumptions of perfect competition (Mastrianna 2010). Firstly, there are several sellers in the market selling homogenous products. This follows that there is no product differentiation. Homogeinity of the product refers to the phenomenon that the buyers are unable to differentiate between the products made by different suppliers; the product of one firm is considered completely substitutable by the product made by another firm operating in the same market. As a result, no firm is able to gain any competitive advantage over another firm (Dwivedi 2006). There is no branding that separates one product from the other. The products are characteristic of the same level of quality and no advertising is carried out to promote one product over the other. In fact, no measures are adopted that differentiate one product from another. Also, there are a large number of buyers in perfect competition. This follows that the individual share that each buyer has in the demand for a product is very small, and no individual buyer can significantly affect the market price for the product by changing its individual demand (Dwivedi 2006). The second assumption of perfect competition is that buyers and sellers are well-informed about the market and the prices. There are no secrets between the firms. For instance, if a seller sets a price for a product which is less than the price other sellers have set for the same product, all consumers are informed about the difference in prices. All the knowledge in perfect competition is shared and if one company is able to produce a product at a lesser cost, the process does not remain a secret and soon other companies acquire the knowledge and start producing products at a lesser price too (Mastrianna 2010). The third assumption of the theory of perfect competition is that there are no barriers to entry and exit in the market. If a company wants to break into a market, it does not face any barriers. The absence of barriers also gives rise to the notion of perfect mobility. This means that resources can be easily shared between different sellers, without any impediments. The perfect competition theory also holds that all necessary resources needed by firms are also available, and there are no restrictions set forth in rules and laws by the government or any other condition that may prove to be an obstacle in the production of goods and services. There is perfect labor mobility and employees can move from one firm to another without any barriers to their migration. Employees are also free to move from one occupation to another due to the absence of any barrier such as legal, language, climate, skill or distance (Dwivedi 2006). Moreover, there are no trade unions in a perfectly competitive market structure. There are no restrictions on the movement of capital between firms. There is no existence of monopoly over any industrial input. As a consequence, factors of production, which include land, labor, capital and entrepreneurship, are free to enter or exit the market. Since there are no barriers to entry, if a firm makes supernormal profits due to any reason, new companies can enter the market and the supernormal profits are eradicated. Likewise, due to the absence of any barrier to exit, firms making low profits or having opportunities of making greater profits elsewhere are free to leave the market (Dwivedi 2006). The fourth assumption of the theory is that no buyer or seller can affect the market price for goods; rather the determinants of market price are the demand and supply of the product. For this provision to be valid there must be a large number of suppliers in the market so that none of them could have a large impact on the pricing of a good. Also, when there are fluctuations in the production of a good, the effect must not reverberate to the level of market supply of the product; this can only be possible if the number of suppliers is large. The firms in a perfect competition are price-takers and they must comply with whatever price is set by the trends in demand and supply. Arnold (2010) defines a price-taker as one who “does not have the ability to control the price of a product it sells; the seller takes the price determined in the market”. Sellers cannot set a higher price for their goods because all the products in the market are similar. However, this does not eradicate the possibility that if all the firms were to increase their output, the act would significantly affect the supply and would change the price of the product (Mastrianna 2010). The Mathematical Elements of Perfect Competition Perfect competition is based on two elements: pure competition and perfect market. In perfect competition, the industry price of the product is found out by the intersection of the market demand and the supply of the product (Deepashree 2007). Firms are subject to a perfectly elastic demand curve. When plotted on a graph, the demand curve of the firm is a horizontal line. This means that the all the supply of the firm can be sold at the price of the product as determined by the market. Profit is calculated from taking the difference between the average total cost of production and the selling price, and multiplying the answer by the number of units sold. The aim of firms is to maximize the profits that they make, each firm aims to produce as many units as would be sufficient to generate the maximum profit when they are sold (Mastrianna 2010). Agriculture in developing countries is often drawn as an example of perfect competition. It can be seen that many farmers are unable to influence the price of the product that they grow at farms and so most of the farmers are price-takers (Mukherjee 2007). Perfect competition aims to improve the performance of the firms operating in the market. It is also assumed that this system is more efficient than other types of market structures. The market output is optimized and comes to equal the level of the minimum average cost. The consumers have to pay a price that is barely more than the average cost of the production of the good, and the firms earn a normal profit in the long-run. The consumers are not exploited, and discrimination does not exist. The individual firm functions in an equilibrium with its marginal cost equal to its marginal revenue, which happens to equate the market price of the good. The supply curve of perfect competition market structures originates from the marginal cost curves for the product. In order to determine the supply for the entire industry, the marginal cost curves of individual firms are summed up (Mukherjee 2007). Critics Citing the Existence of Perfect Competition In a perfectly competitive market, there are a number of measures that are taken irrespective of the factors that affect regional competitiveness. Price-takers also aim for the maximization of their profit, but it is argued that for such firms, output decisions should not be made on fixed costs. Moreover, Thomas and Maurice (2008) also observe that in a perfectly competitive market, firms are engaged in production even when they are not making money. The managers do not halt the process of recruitment and hiring of labor when the productivity of the labor is diminishing. Moreover, Thomas and Maurice (2008) state that in perfect competition market structures, the firms may not earn any economic profit in the long run if there are no barriers to entry. This comes to establish that on the regional level, competitiveness is not driven by the availability of factors, and the normal factors such as declining labor productivity which would elicit lay-offs by the managers, are not a determining factor for operation of firms in perfectly competitive markets. Thomas and Maurice (2008) observe that although the characteristics of a perfectly competitive market structure appear to be very focused, many managers are subject to market structures that closely resemble the structure of a perfect competition. In fact, Thomas and Maurice (2008) observe that in an executive MBA class of 38 manager-students, 34 students reported that their firms did not have, if any, influence on the prices of the products that they produced and the prices were under the control of market forces beyond the reach of the firms. Critics Citing the Unrealism of Perfect Competition Some critics are of the point of view that the theory of perfect competition gives economists what they want. If the theorists want the firms in a perfectly competitive market structure to be the price-takers, they devise assumptions that make them so. However, Arnold (2010) refutes this opinion and argues that economists come to such conclusions after systematically studying and observing the patterns associated with the hypothesis. When considering the existence of competition between regions, one can see that there are differences between regions, and some regions seem to do better than others; they have greater employment, a better standard of living and are more prosperous. Bagchi-Sen and Smith (2006) assert that there is competition between locations and spaces for instance for capital, labor and markets. There are many theories that augment the argument of the presence of competition between regions. The Marxian economic geography also reflects the idea of “competition between places” (Bagchi-Sen & Smith 2006). There were many arguments that cemented this perspective, and one such argument was that due to the changes in technology, costs and the conditions of the market, there is a regular movement from one region to another in the search for opportunities of making greater profits in various geographical locations. Bagchi-Sen and Smith (2006) observe that in the search of the most profitable locations, capital, essentially, “plays off different regions according to their relative advantages for accumulation”; this means that development in one region occurs at the cost of another region. It can be deduced from this statement that regions are competing against one another. It also comes to establish that factors do play a part in the development of regional competitiveness. Bagchi-Sen and Smith (2006) regard this process to be merciless and characteristic of outright denial of the development of an equilibrium economic landscape. Moreover in the context of capital, this process contributes to the consistent reshaping of the relative advantage of various locations. Bagchi-Sen and Smith (2006) also observe that where P Krugman had completely denied national competitiveness, he is now of the opinion that it may have specific relevance to the regional dynamics of interaction. The Neoclassical Theory of Competition The central theory relating to competition policies today is considered to be the neoclassical theory of competition, monopoly and industry organization. In this perspective, competition is regarded as a form of an industry structure; this is further divided into perfect and imperfect. In the neoclassical perspective, the role of the economy is to use its resources in an efficient way and to increase the welfare of the consumers. However, if such a perspective is implemented, it results in structural market failure. As a result, the government has to take measures to correct it but the task of the government is not very easy. This is because in reality, perfect competition and monopoly are regarded to be completely opposite to each other and are “recognized to be unrealistic” (Wignaraja 2003). This makes brings to limelight the importance of oligopolistic competition. An oligopoly is characterized by a market structure where there is increased interaction between the firms, and the firms are affected by each other’s activities. Furthermore, a second problem with the neoclassical theory is that both perfect competition and monopoly are subject to the same cost and demand trends, technology and resources, and so both have them have identical effects on the growth and performance of the economy (Wignaraja 2003). Citing the Role of Factor Availability in Perfect Competition Harris (2003) asserts that in the real world, many of the assumptions of perfect competition do not hold any substance. Perfect competition present in all factor and product markets, perfect mobility of labor etc. is not present in the real world. Krugman (1997) states in an argument relating to the market potential approach, that the good produced by the US and EU are not perfect substitutes of each other and so there is no existence of perfect competition. Perfect information is not present, and so firms are unable to make informed decisions regarding output and entry and exit in the real world (Oxley & Yeung 1998). Younkins (n.d.) furthers this point of view and observes that in the dynamic business world of today, it is not possible to have perfect competition. The model becomes irrelevant because there is imperfect information that is available. Perfect competition can be regarded as a process, not a structure, where a company which aims to increase its profits is exposed to only a restricted degree of information and works for the alignment of its business processes with the needs and wants of the consumers. In the real world, there are divergences from the assumptions of the theory of perfect competition. Where the theory assumes that all products available in the market are homogenous, in effect, there is a lot of product differentiation that is present in the market. George Reisman asserted that the Platonic ideal of pure and perfect competition traces its roots back to the philosophy which is based on the notion that a person is controlled by, and accountable to, a greater entity- Society, the State, or Mankind (Younkins n.d.). This gives rise to the view that private property of the individuals is not really their own, and their business activities are under the control of the greater entity. Therefore, Younkins (n.d.) is of the perspective that pure and perfect competition is an “unrealistic and mistaken ideal”. Maki: the Unrealism of Perfect Competition Maki (2001) observes that one popular criticism of models or theories is related to the aspects that they have not covered. This is considered a common type of criticism that points to the notion that the theory or model is unrealistic: “a theory is unrealistic if it is unjustifiably “narrow”- that is, if it excludes from consideration factors that are deemed important” (Maki 2001). One such critic, Richardson, regarded the theory of perfect competition to be unrealistic based on the grounds that it does not take into account the workings of the modern world. In Information and Investment, he wrote “Perfect competition, I shall affirm, represents a system in which entrepreneurs would be unable to obtain the minimum necessary information; for this reason, it cannot serve as a model of the working of actual competitive economies” (Maki 2001). He further went on to write that the theory does not include on the most important elements of the attainment of equilibrium; in fact, the major part of the theory does not even take into account the need for this element to be included. He observes that in the theory, there is no explanation provided that in the conditions that shape the perfectly competitive market, how are entrepreneurs going to acquire the information on which they are going to base their expectations as well as their investment. The theory of perfect competition does not give an explanation of the way free enterprise economies actually function. Richardson was of the view that the economies operate only when there is a certain degree of imperfection of competition, because under these conditions, the enterprises can meet their informational requirements originating from the need to make informed investment decisions (Maki 2001). Free Trade Theory The free trade theory is another theory that derives its assumptions from the perfect completion market structure. However, Krugman (1987) observes that there are arguments that are being raised against the free trade theory, one of which relates to the presence of imperfect competition in the markets. International trade is considered to be largely controlled and driven by the economies of scale as compared to comparative advantage. Moreover it has also been seen that international markets are primarily imperfectly competitive. The theory of perfect competition assumes that the profitability of the firms and regions is not achieved at the cost of other firms or regions. However, Krugman (1987) asserts that when it comes to international trade, the country is able to increment its national income at the expense of other countries. However this can happen if the firm which is excess returns is domestic and not foreign; this helps to point to the fact that the assumptions of the theory of perfect competition are not applicable to international trade. One of the arguments made against international free trade is the strategic trade policy argument which holds that under certain conditions, the government can play a role in the promotion of the national welfare by aiding domestic firms in international competition at the cost of other countries. This also provides another counterargument to the presence of perfect competition since the theory holds that there should not be any government intervention; yet, the strategic trade policy argument regards the role of the government as important in increasing national welfare. Krugman (1987) presents another argument in favor of imperfect competition being the norm. He observes that the most reasonable source of positive externalities is regarded to be the lack of capability of innovative firms to appropriate completely the knowledge that they make. This problem of appropriability is rampant in firms that are undergoing rapid advancements in technology and is representative of the activity of the firm to take apart the product of the competitor to see how it works. Krugman (1987) observes that in international trade models, where increased dependence is placed on perfect competition, externalities that are the result of incomplete appropriability cannot be clearly identified; the reason for this is attributed to the inability of the firms to fit in their knowledge investment, which is the source of spillover as well. This follows that investment in knowledge develops a fixed-cost aspect. As a result, when a firm makes a good and has improved it subsequently, the unit cost of improvement decreases as more of the product is made. Therefore, one can establish that the consequence of these dynamic economies of scale would result in the collapse of perfect competition. Models of perfect competition are unable to explicitly identify the most reasonable reason for the presence of external economies (Krugman 1987). Porter and other critics on the need for factor availability In another argument relating to producer behavior, Fujita, Krugman and Venables (1999) present the notion that the manufacturing industry functions in a market structure that is far from perfect. The agricultural and farming side of production can be regarded as an industry where there is constant-returns technology being used. However manufacturing entails the economies of scale. The argument concludes that due to the increasing returns to scale in manufacturing, the choice of the consumers for variety, and the array of potential varieties of the goods produced, no business will make the same type of good as the other business makes. This conclusion is completely in clash with the assumption of the theory of perfect competition that the goods produced are homogenous. Michael E. Porter (1990), in his article, The Competitive Advantage of Nations, provides another strong argument to the view that factor availability is an important element in the development of regional competitiveness. Porter argues that the prevailing thinking further the perspective that the costs of labor, interest rates, exchange rates and the economies of scale are regarded as the most important and potent factors that affect competitiveness today. In the modern business world of today, the words that have become part of routine conversation are merger, alliance, strategic partnerships, collaboration and supranational globalization. Clusters, defined as critical masses that provide extraordinary competitive advantage in some fields, also affect competitiveness between regions (Porter 1998).Managers are involved in the process of acquiring greater support by the government. Even the governments are more inclined and are engaged in experiments to promote their national competitiveness. These include measures to balance and stabilize the exchange rates, as well as policies relating to the shift the trade in the favor of their country and measures to relax antitrust. Porter, after conducting a four-year study, draws the conclusion that firms are able to achieve competitive advantage through innovation. Innovation can be derived from a number of sources. It may come from a new company, or it may occur due to any diversification that the company undergoes. Porter comes to the conclusion that the only way that companies can retain and sustain this innovation is by constantly upgrading it. Some critics believe that technological capabilities are in essence national and can be produced by national action (Cooke & Morgan 1999). Conclusion In conclusion, the definition of national competitiveness is not clear. The determinants of national competitiveness, such as exchange rates, interest rates and government deficits, are not accepted by all critics. This is because countries such as Japan, Italy and South Korea, have all been subject to a rapid increase in the standards of living, despite the fact that they were burdened by huge government deficits. Moreover Germany and Switzerland have also seen an increase in the standards of living despite their appreciating currencies. Italy and Korea have also progressed although they had very high interest rates. Another recent development in the field of national competitiveness is that it is the result of government policies relating to imports and subsidies amongst other aspects. Some critics link national competitiveness to bountiful resources while others consider it to be a function of inexpensive and plentiful labor (Porter 1990). As discussed above, perfect competition theory assumes that the firms have no control over the price of the products produced, and in essence, competition is driven without any control by factors. The arguments presented in the later part of the paper have come to establish that perfect competition is unrealistic and is pretty much restricted to agriculture and the financial markets (Williamson & Milner 1991). Perfect competition does not operate in the dynamic business world of today. This follows that there is a need factor availability is vital to the determination of regional competitiveness. Reference List Arnold, RA 2010, Microeconomics, Cengage Learning. Bagchi-Sen, S & Smith, HL 2006, Economic geography: past, present and future, Taylor & Francis. Cooke, P & Morgan, K 1999, The associational economy: firms, regions, and innovation, Oxford University Press. Deepashree 2007, General Economics For Ca Cpt, Tata McGraw-Hill. Dwivedi, DN 2006, Microeconomics: Theory and Applications, Dorling Kindersley Pvt Ltd. Fujita, M, Krugman, PR & Venables, AJ 1999, The Spatial Economy: Cities, Regions and International Trade, MIT Press. Harris, JM 2003, Rethinking Sustainability: Power, Knowledge, and Institutions, University of Michigan Press. Krugman, P 1987, ‘Is Free Trade Passe’, The Journal of Economic Perspectives, vol. 1, no. 2, pp. 131-144. Krugman, P 1996, Pop Internationalism, MIT Press. Krugman, PR 1997, Development, geography, and economic theory, MIT Press. 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