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High Quality vs Low-Cost Bargain: The Current Dichotomy! (III). Unsolved issues of the National Competitive Advantage (Part A)

Have a beautiful week. Today we will continue sailing through the winds of the National Competitive Advantage theory which is the basis of the major last developments of our global free-trade system since the 90s.

“Baby chin-chin”. An aquarelle painted for this blog. Handmade with love by Eleonora Escalante on paper Fabriano 5-240GSM. Size: 7 inches x 5 inches.

The theory of Porter’s “National Competitive Advantage” has been criticized since its conception but it was an instant hit in academic and business circles. The book of Michael Porter “Competitive Advantage, creating and sustaining superior performance” first edition was published in 1985. But I read and studied the book edition of 1998, because that was the time in which I was living in London, Santiago and New York, where I got my post graduate degrees in business administration and engineering management. Michael Porter combined the body of knowledge of industrial organization (a branch of economics) and promoted what it has been coined as the “positioning school of thought” in strategy. Some studious strategists believe that Michael Porter concepts in economics and strategy are mingled with the strategy design and planning schools of thought. But before starting to list the unsolved issues of the National Competitive Advantage, we always have to start with the past history. Please, if something that Eleonora Escalante Strategy is trying to rise is the importance of going back to the roots of our issues. If the journey to our past takes us to go back 50 years or 3 centuries or a millenium, that is time in history that we have to rewind, in order to understand the roots of our current complex problems. So take a breath, and relax. We will begin today with some historic background.

Some historic background of the National Competitive Advantage Theory. We can´t analyze the unsolved issues of the current outstanding free-trade theories before understanding the past. Our economic theories are simply a legacy of the mercantilism that was propagated in the 16th and 17th centuries.  Given the restrictions of time in this blog outline, I will highlight the most relevant information starting as of the mercantilism period of our history, and I will try to squeeze 500 years of economics and international trade in just one week of publications. Of course you are free to read the textbook “Global Business Today”. This textbook is basic, but its simplicity takes us to comprehend rather than complicate our learning path. Charles Hill “Global Business Today”, should be a reference for international business, regardless if you are a free-trade guru or you are not working in this area.

Let’s begin with our journey to our past most relevant international business and trade theories.

  1. Mercantilism: This was the first theory of international trade that emerged from Britain in the mid 16th century. This theory of international trade stated that it is in a country’s best interests to export more (sell more to foreign strangers) than to import from them (buy less of theirs in value). At that time gold and silver were the currency of trade between countries. If a country would accumulate gold and silver, it had to export more than it imported, and consequently increase its national wealth and prestige. The concept of trade surplus was originated here. Trade surplus was the motto then. And mercantilists recommended policies to maximize exports and minimize imports. The flaw of the mercantilism was that it viewed trade as a zero -sum game) in which a gain in one country is the loss by another one). Believe it or not, this theory has not disappeared, particularly now, because it is being used by many countries that apply some kind of protection to its industries´ economies.
  2. Absolute Advantage: Adam Smith’s theory of absolute advantage was proposed in 1776. His economic theory aimed to explain why unrestricted free trade was beneficial to a country. Smith noticed that each country differs in their ability to produce goods efficiently. The combination of local resources (favorable climate, good soils, accumulated expertise, excellence in manufacturing process, talented people, efficiency in the industry, etc) creates an absolute advantage in a country, while producing a product in comparing to other nations. Smith´s basic argument stated that each country should never produce goods at home that can buy at a lower cost from other countries. Smith encouraged the specialization in the production of goods in which each country has an absolute advantage, so both countries can benefit engaging in trade.
  3. Comparative Advantage: The Theory of Comparative Advantage from the 19th century, developed by David Ricardo is the intellectual basis of the modern unrestricted free trade. Basically Ricardo took Adam Smith’s theory one step above, by confirming Smith’s philosophy, and deepened the idea “potential world production is greater with unrestricted free trade than it is with restricted trade”. He suggested that trade is a positive-sum game in which all gain, instead of a zero sum game. So, Ricardo´s book message of 1817, “Principles of Political Economy”, was that it makes sense for a country to specialize in the production of those goods that it manufactures most efficiently; and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself”. Nevertheless Ricardo´s theory was based in several assumptions (limitations) that we will refresh on our next article.
  4. Heckscher-Ohlin Theory:  From the basis that Ricardo´s theory about comparative advantage arises from differences in productivity and efficiency, the Swedish economists Eli Heckscher (1919) and Bertil Ohlin (1933) put forward a different explanation of comparative advantage.  They put the concept of factor endowments into the table. By factor endowments  they meant the extent to which a country is endowed with such resources as land, labor and capital. So, for Heckscher and Ohlin the argument of comparative advantage arises from differences in national or domestic factor endowments rather than differences in productivity.
  5. Product Life-Cycle Theory: Raymond Vernon proposed this theory in the mid 1960s. This theory explains certain patterns in which practice by the learning curve explains the process of exports in free-trade. This theory suggests that early in their life cycle, most new products are produced in and then exported from the country in which they were developed. As a new product becomes widely accepted internationally, however, production starts (as a similar or copycat competition) in other countries. As a result, the theory suggests that the product may ultimately be exported back to the country of its original innovation. Multiples examples of this theory abound, particularly in the technology and communications industries. The majority of them related to mobile and consumer electronics technologies, in which they are designed and created in the United States or in Germany, then manufactured in Asia, just to return back to the United States, under a new international brand, to the country of its original creation.
  6. New Trade Theory: During the 1980s, economists such as Paul Krugman of MIT developed what has been  baptized as the new trade theory. Basically the new trade theory stresses that in some cases countries specialize in the production and export of particular goods not because of underlying differences in factor endowments (as Heckscher Ohlin told us) but because of the nature of the industries. Certain industries in the world market require high initial and working capital investments or a vast presence of substantial economies of scale (at all levels of capital: manufacturing fixed assets, financing, research and development, human capital, know-how, usage of the newest technologies, and other endowments). In consequence these industries can support only a limited number of firms in the global market. In these industries, the firms that enter the market, first build a competitive advantage that is subsequently difficult to replicate and challenge. As a result the observed pattern of trade between nations may in part be caused by the ability of these firms within a given nation to capture first-mover advantages. An early entrant into an industry is called first mover advantage, because they are able to gain economies of scale, and may lock on the world market that discourages subsequent entry. In one phrase, this theory suggests that a country may dominate in the export of a product simply because it was lucky enough to have one  or more firms among the first to produce that good. In addition these firms are able to establish the dominance ( beginning as a monopoly, then an oligopoly), which is the basis of the Multinational Corporations (MNCs) existence. These following industries are related to the paradigm of first-mover advantages: the commercial aviation, the chemical, the oil and gas, the heavy construction-equipment, the heavy truck, the car manufacturing, the consumer electronics, the mobile technologies industries, etc. The new trade theory stress the role of luck, entrepreneurship and innovation in giving a firm first-mover advantage. But in addition it also implies that the role of government intervention and strategic trade policy for those specific industries play an important role to increase the chances of emerging domestic firms to become first-movers at the international level. For example, it is being said that one of the most successful jet air-craft manufacturers first mover advantage, was largely paid for by the US Government, which funded all its R&D process for its successful plane model which was a spin-off from the US state funded military program.
  7. National Competitive Advantage: And here we are landing with the 1990s theory of Michael Porter. Porter tried to provide a much more broad explanation to the trade theories. Porter offered the Porter’s Diamond as the determinants of the National Competitive Advantage. We will stop here, because I will dedicate one whole article to explain this theory of international trade which has been privileged during the last 30 years. All with the purpose to then explain which are the key issues with it. See you next friday.

To be continued…

Sources of reference utilized for this chapter:

Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY.  Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine.  I do not own any of the lovely photos or images posted unless otherwise stated.

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