Competitive Advantage

An improvement on the traditional theory of comparative advantage is the theory of competitive advantage. Unlike the Ricardian model, which was useful for understanding the simpler economies of the early period of the Industrial Revolution, this approach focuses on the social creation of innovation in a rapidly changing, knowledge-based economy. The key to competitiveness in this view is productivity growth: Over the long run, rising productivity creates wealth for everyone, if not equally. Productivity growth in turn reflects many factors, including the education and skills of the labor force, the available capital and technology, government policies and infrastructure, and the presence of scale economies.

Competitive advantage is dynamic and changes over time. The goal of national development strategies is to move into high value–added, highprofit, high-wage industries as rapidly as possible. To accomplish this goal, firms and countries should seek to sell high-quality goods at premium prices in differentiated markets. Quality is a key variable here; countries often acquire reputations for producing high- or low-quality goods, earning (or not earning) brand loyalty as a result. By moving into high value–added goods, nations seek to automate the low-wage, low-skill functions and retain the knowledge-intensive ones.

Although the global economy is increasingly seamless, competitive advantage is created in highly localized contexts—that is, within individual metropolitan areas. Globalization therefore does not eliminate the importance of a home base. Thus, countries that succeed internationally do so because a few regions within them move into “cutting-edge” products and processes. Within the United States, propulsive regions include Silicon Valley, Boston's Route 128, and New York, with its premier position in finance and producer services; in Europe, they are Italy's Emilia-Romagna, the continent's largest high-technology region, as well as Germany's Baden-Wurtenburg, Denmark's Jutland peninsula, and the Cambridge region of the United Kingdom; in Japan, the government has actively constructed a series of technopolises toward this end (e.g., Toyota City).

The overall determinants of competitive advantage include the following: skilled labor, good educational systems, and technical training; agglomeration economies, including pools of expertise, webs of formal and informal interactions, trust, linkages, strategic alliances, trade associations, and integrated networks of suppliers and ancillary services; and a culture that rewards innovation—adaptation, experimentation, risk tolerance, and entrepreneurship—which includes heavy levels of corporate and public research and development and the continual upgrading of capital and skills. Corporations must engage in ongoing and organizational learning, anticipating changes in markets and demand; rigid corporate bureaucracies, like public ones, lead to complacency and short planning horizons. Competitive firms operate within competitive domestic markets; uncompetitive markets (i.e., private or public monopolies) exhibit little innovation. In the world economy today, increasingly sophisticated buyers spur a constant upgrading in the quality of output; adequate financing and venture capital; public policies that encourage productivity growth, including subsidized research, export promotion, and educational systems; and an up-to-date infrastructure (i.e., airports, telecommunications).

The theory of competitive advantage, largely attributable to Michael Porter, concludes that four attributes of a nation combine to increase or decrease its global competitive advantage and world trade:

• 1.
  Factor conditions
• 2.
  Demand conditions
• 3.
  Supporting industries
• 4.
  Firm strategy, structure, and competition

Factor conditions, or production factors, include human resources (the quantity of labor, skills, educational level, human capital, productivity, and cost of labor), physical resources (raw materials and their costs, location, access, and transport costs), capital resources (funds to finance the industry and trade, including the amount of capital available; the savings rate; the health of money markets and banking in the host country; government policies that affect interest rates, savings rates, and the money supply; levels of indebtedness; trade deficits; and public and international debt), knowledge-based resources (research, development, the scientific and technical community in the country, its achievements and levels of understanding, and the likelihood for future technological support and innovation), and infrastructure (all public goods and services necessary to facilitate the production of goods and services that provide a country with a competitive advantage). Also included are transportation systems; communications and information systems; housing, cultural, and social institutions; and education, welfare, retirement, pensions, and national policies on health care and child care. These five factors are identified in current international and economic circles as the keys to the competitive advantage of a nation in the foreseeable future.

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