Factor Availability and Competitiveness in International Trade - Case Study Example

 Introduction The concept of the open market is premised upon the interaction of many buyers and many sellers of goods and services, with the participants in either side free to make choices to either transact or not, with full information about the products and the conditions of the market. Necessarily, there will be criteria along which lines the decision to transact or not will be made. The factors that enable one seller – or buyer, for that matter – to outperform other participants would therefore tend to become a matter of great interest, the determination of which would be the objective of many academic inquiries with a view towards forecasting market behaviour. The large scale version of such a market would be the global market for goods and services. Whereas in a market confined to a single economy, the determinants would pertain to individual firms within an industry, in the global economy the participants are countries and therefore the parameters are different. Conventional theory has it that microeconomic considerations would be relevant for intra-firm competitiveness, but would not be of particular importance in intra-country competitiveness. Rather than microeconomic concerns, macroeconomic dynamics were thought to be the overwhelming determinant in countries’ global competitiveness. This discussion will dwell on the topic as to what degree factor availability explains the competitiveness of participants in the global market, whether they be regions or countries, and at what point it no longer provides an effective explanation. This essay will therefore seek answers on the following discussion points: 1. What factors are acknowledged by academic theory to explain the competitiveness of countries in the global economy? 2. What circumstances would tend to negate the usefulness of such factors in explaining competitiveness? Factors of Production The factors of production are the inputs necessary to produce goods and services. Basic economic theory states that there are generally acknowledged four factors of production – land, labour, capital and entrepreneurs. Of these, the most important factor of production is labor, because the labour force in an economy receives the greatest share of the income generated in that economy (Mankiw, 2009, p. 407). The market for the factors of production is similar to any other market in the economy, but with one distinction: it is an important determinant of economic activity. The demand for each factor of production is a derived demand. This means that what determined the demand of a firm for each factor of production is the result of the firm’s decision to supply the good or service in another market. In analyzing how labour costs affect competitiveness, there are two important dimensions to consider: that portion of the costs known as direct costs, and those that pertain to quality of labour. Direct costs of labour involve compensation, both wage and non-wage (Agesa & Hamilton, 2004). These costs are largely the subject of regulatory legislation in many countries which prescribe a minimum wage, cost of living allowance, overtime pay, pensions, benefits and other mandatory compensation. In time, due to constant adjustments in the standard of living, direct costs may adjust in a relatively short period of time. The second type of cost has to do with the quality of labor, which encompasses productivity, skills, creativity, and flexibility. These are more complex costs, which adjust more gradually over longer time spans (Yochelson, 1999, p. 100). Factors of comparative advantage Traditional economic theory has an expanded list of factors that determine the comparative advantage among nations. These include land, labor, location, natural resources (i.e. bodies of water, oil and mineral deposits, flora and fauna), and local population size. These factor endowments are inherent in the country and could not be influenced, for which reason they comprise the passive or inherited view of sources of national economic competitiveness (Value Based Management, 2010). There are actually many determinants of national competitiveness. One of these is the competitiveness of factors of production, most particularly labor. Other elements are firms’ business strategies that are comprised of the sum total of business decisions made by firms’ managers on their goals and profit targets; the institutional framework of the country, including the financial, legal, and administrative infrastructure; and the overall reputation of the country as a site for doing business, inclusive of considerations such as the existence of tax shields and the prevalence of corruption (Yochelson, 1999). In his study of international competitiveness, Porter devised the Diamond framework for competitive advantage, In this he identified four active factors that governments may influence to enhance their country’s competitive advantage. These interlinking factors are the following (Hill & Jones, 2010, p. 248): 1. Firm strategy, structure and intensity of rivalry – The firms’ strategies and the industry structure foster direct competition which motivate firms to work increasingly towards innovation and productivity, thereby optimizing the opportunities created in a world that is dominated by dynamic conditions. 2. Local demand conditions – Pressure exerted on firms to meet increasing demand by an increasingly discriminating customer pool encourages the firm to strive to improve competitiveness and innovation in their products. 3. Competitiveness of related supporting industries – This refers to the degree of physical separation (otherwise denoted as spatial proximity) between interrelated upstream and downstream industries which allows for the facilitation of information exchange and enhances a more fluid interchange of information and ideas for innovations. 4. Factor endowments – A fresh perspective is introduced by Porter, that factors are not merely inherited (passive) but created. These so-called specialized factors are in the form of skilled labor, capital and infrastructure. These factors are also referred to as key factors, as against the non-key, non-specialized (general use) factors which are unskilled labor, raw materials, and other factors which are capable of being acquired by countries and thus are not sources of sustained competitive advantage. Because specialized factors are a source of long-term competitive advantage, they likewise require a large amount of sustained investment, are more difficult to duplicate, and are thus considered more valuable to the country possessing it and which the country would refuse to relinquish such factors to other countries. The four preceding attributes form Porter’s Diamond Model, graphically depicted in the foregoing diagram. Each of the factors affect the other three, and all four factors are to an extent influenced by government intervention, usually intentionally in line with state policy, but often also unintentionally through the government’s actions in other related aspects of governance. Porter’s Diamond Model. Source: Value Based Management, 2010. Companies in a particular nation will tend to succeed in strategic groups or industries where the four attributes are favourable. The four elements are situated in a mutually reinforcing system, and each attribute’s effects depend on the state of the others (Hill & Jones, 2010, p. 248). Here government is allocated the role of catalyst for change, challenging individual companies to attain ever-improving levels of performance, spurring demand that creates impetus for innovation for the design and production advanced products. The government also ideally limits direct cooperation among companies and enforces anti-trust regulations in order to encourage the creation of specialized factors and stimulate a healthy local rivalry (Value Based Management, 2010). Concerning the labour factor of production, the level of preparation of the labor force to meet future jobs, innovation, and new technological developments are determining criteria for competitiveness. Likewise, the management efficiency, especially as applied to financial resources (i.e., capital factor of production), will be determinative of long-term competitiveness (Yochelson, 1999, p. 112). Regional Factors of Competitiveness National competitiveness in the global marketplace is what was contemplated in the traditional theories and in Porter’s comparative advantage diamond model. Such models could be made more explicit in the case of particular regions that comprehend a single economic and regulatory regime. The only case of its kind at present is the European Union, which through the centuries since after the Second World War have moved increasingly towards a totally integrated, seemless and borderless economic system, propelled by the adoption of a single currency and the creation of a single labour pool, and reinforced by a unified judicial system. In the interest of determining the impact of this unified region that is still continually expanding, studies have been conducted under the auspices of the European Commission to determine the drivers of competitiveness of the region in the global arena. The following table shows the result of the study. Source: Martin, 2006, p. 2-32 Overview of Regional Factors of Competitiveness Infrastructure & Accessibility Human Resources Productive Environment Basic Infrastructure (road, rail, air, property) Demographic trends (migration of skilled workers, diversity) Entrepreneurial Culture (low barriers to entry, risk-taking culture) Technological Infrastructure (ict, telecoms, internet) High skilled workforce (knowledge-intensive skills) Sectoral Concentrations (balance/dependency, employment concentration, high value-added activities Knowledge infrastructure (educational facilities) Internationalisation (exports/global sales, investment, business culture, nature of FDI) Quality of Place (housing, natural surroundings, cultural amenities, safety) Innovation (patents, R&D levels, research institutes and universities, linkages between companies and research) Governance & institutional capacity Capital availability Specialisation Nature of competition The table classified the factors of competitiveness into three general groups – the productive environment, infrastructure and accessibility, and human resources. Under each classification are several specific factors and the components that comprise each factor. All the factors mentioned would be described as those elements Porter’s theory would identify as factor endownments, or specialized/created. Such factors are determinative of the sustained competitive advantage, adding credence to the validity of the Diamond model. Determinants and Measure of Competitiveness Competitiveness is an elusive concept, and a comparison of national competitiveness necessitates the designation of a measure as the criterion. One method is to link the macroeconomic concept of external balance to the microeconomic concept of price competitiveness. The costs and pricing strategies of individual businesses affect and are affected by the prices of exports and imports; and yet, macroeconomic factors, represented by indicators such as interest rates and foreign exchange rates, affect price competitiveness in a manner that is not susceptible to control by businessmen (Yochelson, 1999). One broad measure of international competitiveness is the “Davos index,” which is monitored by the World Economic Forum. The Davos index is a combination of eight factors, namely openness, government, finance, infrastructure, technology, management, labor and institutions. Each of these factors are in turn determined by a set of subindexes that include survey data (which are relied on more in determining infrastructure, technology, management quality, and institutions), and quantitative indicators (which are relied on more to determine openness, government, finance and labor) (Yochelson, 1999, p. 111). More sensitive measures have been developed to try to capture the complex nature of national competitiveness. The World Economic Forum (WEF) tracks in its Global Competitiveness Report (GCR) the comparative ratings of countries according to two indices, namely the Current Competitiveness Index and the Growth Competitiveness Index. The Current Competitiveness Index is constituted on the use of microeconomic data that “measure the set of institutions, market structures, and economic policies supportive of high current levels of prosperity;” on the other hand, the Growth Competitiveness Index is centered on measuring the global competitiveness of countries, based on their set of institutions and economic policies that would tend to support medium term high growth rates (i.e., sustainable for the next five years). The reason for the use of two measures is elaborated on in the GCR, which states that a prosperous economy could not be ensured merely by sound macroeconomic policies and a stable environment, necessary and desirable as these are. Much of the differences in the GDP per capita of countries are accounted for by the existence of variations in the micro-economic indicators. The interplay of micro- and macro-economic elements in driving competitiveness has been mentioned earlier in this paper, and remains to be a continuing theme in the determination of comparative measures of countries’ competitiveness. As the WEF contends, “In advanced countries, which have largely gotten their macro policies right, it is micro reform that holds the key to reversing unemployment problems and translating economic growth into a rising standard of living” (Martin, 2006, p. 2-21). This observation of the WEF brings to fore the need for countries to give as much importance and attention to the microeconomic dynamics of firms and households whose individual market actions collectively impact on the economy’s competitive profile. The Current Competitiveness Index (CCI) is therefore WEF’s attempt to capture this impact of microeconomic elements. The CCI is an aggregate of two sub-indices, one of which measures company sophistication, while the other captures the quality of the national business environment. On the other hand, the Growth Competitiveness Index (GCI) measures the attributes that pertain to the level of technology, the degree of development of public institutions, and the general macro-economic environment (Martin, 2006). Determinants of Comparative Advantage in Services Competitiveness among countries pertains to the sale and transfer not only of goods, but also of services. The past twenty years witnessed phenomenal growth in the international trade in services. The nature of services puts special demands on circumstances that attend its international trade. According to the definition in the 1993 System of National Accounts of the Organization for Economic Cooperation and Development (OECD), “Services are outputs produced to order and which cannot be traded separately from their production; ownership rights cannot be established over the services…; however, as an exception to this rule, there is a group of industries generally classified as service industries, some of whose outputs have characteristics of goods” (OECD, 2000, p. 40). There are four modes of trading services identified by the OECD and reproduced from Nyahoho (2010, p. 2) are depicted in the following figure: The four modes underscore the difficulties in determining the factors significant in the enhancement of competitiveness of countries in the services market. While explanatory variables generally approximate those for competitiveness in the market for goods, the importance and effectiveness of each explanatory variable differs with the category of services. The variables found to be determinative of competitiveness in the trade in services, in varying degrees depending upon the category of services, are physical capital, human capital, per capita GDP, economies of scale, and research and development (Nyahoho, 2010). Elements that adversely influence free market forces It will be recalled that a prerequisite condition for competition is that free and open market conditions exist. Adam Smith was the first to advocate adherence to free market forces during the advent of capitalism; he perceptively observed that the free market is founded on “the pursuit of economic self-interest” (Lott, 2007, p. 1), and that each participant will use his resources to protect and ensure his own benefit. Where this privilege is limited to a few, oppression and inequity result; however, where the power is afforded to all participants, then there will understandably be an equilibrium point reached that serves the interest of all market participants to the level they are personally willing to commit their resources. Even if said market participants choose to withhold their participation for the reason that the price is too high or low, then the choice to withdraw still serves their better interest than otherwise being compelled to commit themselves under grossly disadvantageous terms. Specific tariffs. There are instances when barriers are set up that would tend to impede the free transfer of goods and services across national borders. With the erection of trade barriers, there is a curtailment of the access of market players to economies where factors of production are more accessible or available. One of these is the existence of specific tariffs. These are tariffs levied on quantity rather than on value (ad valorem), and are less transparent than the latter. They also create a negative impact that offsets the advantages presented by the lower tariffs imposed as a percentage of value. Specific tariffs are more often imposed on agricultural products, thereby discriminating in particular against low-income countries and developing countries. Ad valorem tariffs are more transparent because as product prices and exchange rates fluctuate, the fixed tariff rate imposed on the value varies accordingly. Specific tariffs, because they are levied on the quantity of goods imported, do not fall when commodity prices fall, making market access increasingly difficult. Furthermore, when obtaining the assessment of overall protection levels, it becomes necessary to calculate the ad valorem equivalent of specific tariffs, a complication that reduces rather than enhances the accuracy of the result (Mimouni & Von Kirchbach, 2003). Non-tariff barriers. There are regulations that do not involve tariffs but which likewise set up barriers that intervene in free market access where factors are available. Examples of these non-tariff barriers, which LDC studies indicate affects least developed countries (LDCs) more, are such regulations as animal health standards, food safety standards, environmental certification and other similar export quality standards. It is reported that as high as 40% of all LDC exports are subjected to non-tariff barriers, compared to developing and transition economies of which only 15% of exports are affected. Because of non-tariff barriers, the share of duty-free LDC exports as percentage of their total exports fell dramatically from 815 to 69% in the period between 1996 to 2001 (Mimouni & Von Kirchbach, 2003). Protective government regulations. In many instances, there are government regulations designed to protect local industries by reducing the chances of competition by foreign entrants. Such intention leads to the establishment of regulations that tend to inhibit foreign direct investments (FDI). With the government’s refusal to entry of foreign direct investments, however, is a curtailment of the entry of foreign capital infusions as well as foreign technology transfer. Technology transfer is an important component that attends the transfer of goods and services across borders. Therefore, where restrictions do not pertain directly to goods and services but impact on the effective transfer of technology required for these goods and services, then free market forces are interfered with. The global competitiveness of nations depends on the level of technological innovation (Onken, Fisher & Li, 2005; Pang and Garvin, 2001; Porter, 1990). From the point of view of the developed country, the motivation to transfer technology to another country is born of a need to acquire a competitive advantage in the global market. It is not surprising that transfers are initiated only when the source country is aware of a profitable opportunity to be taken advantage of. On the other hand, government policies of the receiving county likewise affect the prospects of technology transfer when regulations that are established aim to protect local industries from the entry of foreign investment and technology. (Onken, et al., 2005) In a survey of managers of corporations with international operations, Onken et al. (2005) found that a significant number of respondents felt that while government policies and regulations allowed the transfer of technology, they tended to increase the cost of it. Governments are likewise perceived as negatively influencing the incidences of technology transfers. Respondents also felt that where government regulations of a particular country does not by itself unnecessarily hamper technology transfer, the differences between government policies and regulations that exist between and among countries creates the problem. The study proposed that future bilateral and unilateral talks among country representatives should seek to eliminate such discrepancies and arrive at a convention applicable to all. Multilateral negotiations and agreements. The competitiveness of a country’s economy, though it may make available the necessary factors, is significantly influenced by the bilateral and multilateral agreements the country enters into. The most vital organization in international trade is the World Trade Organization, which regulates and enhances more robust trade among its member states. However, as with any undertaking that involves the consensus of several nations, there is the necessary negotiation stage where member states bargain over the means by which gains realized from cooperation under the WTO may be distributed among them. It is to be expected that in the uncertainties of negotiation and the stance of other countries, governments would tend to engage in aggressive gain claiming in order to influence the agreement towards terms more in their favor (Zahrnt, 2007). Aggressive gain claiming has its negative effects. Delays may result, as well as a lowered expectation out of the resulting agreement. Hardline bargaining may result in watered down provisions that would render the agreement less effective than it was intended to be. Further effects may be reduced systemic trust and interest among the member states and a weakening of resolve to implement its terms and obligations, a provocation of peer pressure, and a decrease in the effectiveness and stability in WTO operations. Most importantly, agreements fashioned pursuant to aggressive gain claiming may result in a slowdown in multilateral trade liberalization (Zahrnt, 2007). In this and other political exercises that involve a determination of future actions between countries, that do not have a particular regard for the economic and social attributes of the country, it is possible that competitiveness may be adversely affected (or unduly enhanced) by the play of power and political persuasion. The foregoing have treated on the factors of production and of competitiveness which, based on economic theory, should be determinative of a country’s performance in international trade and the global economy. Presented also were elements that tended to render the availability of such factors insignificant to the country’s eventual performance. Summary and Conclusion This essay set out to discuss the degree factor availability explained competitiveness of participants in the global market, and at what point it no longer provided an effective explanation for competitiveness. In order to arrive at a satisfactory conclusion, answers were sought to the following questions: 1. What factors are acknowledged by academic theory to explain the competitiveness of countries in the global economy? 2. What circumstances would tend to negate the usefulness of such factors in explaining competitiveness? To answer these questions, it was necessary to refer to classic economic theory and the later competitiveness theories to discover what factors were determinative of countries’ competitiveness. Fundamental economic theory states that there are four factors or inputs of production, in particular land, labour, capital, and entrepreneurship, and the efficiency with which these factors are employed by a firm determines the extent to which it may compete and dominate in its market. Market competitiveness here is seen as the relative success of a firm to capture a substantial share of the demand for its particular product or service, while at the same time keeping costs down by efficient and sustainable access to the inputs to production. In the case of the global market, the factors that determine country competitiveness are more specific. Porter distinguishes between passive factors, which a country “inherits” such as its natural resources & unskilled labour, and those specialized factors a country “creates” such as skilled labour, capital and infrastructure. Passive factors may be acquired by other countries and are therefore not sources of competitive advantage, but specialized factors enhance competitiveness because these could not easily be acquired by other countries. At this point, a type of factor availability – the unspecialized factors – no longer determined competitiveness. A country must possess specialized factors to become globally competitive. When countries integrate into regions, the dynamics of competitiveness become more stringent. Martin empirically identifies and classifies 14 specialized factors into three categories of factors, which apply to the European Union as an integrated regional competitor in international trade. Among them are labour in the form of highly skilled work force, land in the form of quality of place and infrastructure, entrepreneurial culture and capital availability, together with innovation, technology, knowledge, governance and institutional capacity, degree of specialization, institutionalization and sectoral concentrations. Factor availability is therefore no longer the singular issue in competitiveness, but the form in which such factors are available. Finally, over and beyond the economic considerations, there are elements that tend to influence, even distort, the free decision-making process that creates the free market conditions necessary for pure competition. These elements include tariffs, in particular non-transparent specific tariffs, as well as non-tariff barriers in the form of export quality standards. Also interfering with free market forces are protective government regulations, and the system of bilateral and multilateral trade agreements that designate most favoured nation status to some countries, for political considerations that have little to do with the availability of factors of production. At this point, factor availability no longer determines the competitiveness of countries. Economic factors are replaced with regulatory, political and diplomatic considerations as major determinants of the decision for countries to trade with each other. These considerations show up as distortionary effects in empirical studies that seek to related factor availability with competitiveness, and are increasingly made the focus of conventions that seek to establish greater liberalization in international trade. 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