Spring 2013_ECO6705- ch 4

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Trade and Competitive Advantage

Chapter 4

The Global Competitiveness Report

• World Economic Forum http://www.weforum.org

• Global competitiveness Indexhttp://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2012-13.pdf

FOUR PILLARSBASIC REQUIREMENTS 1st pillar: Institutions2nd pillar: Infrastructure3rd pillar: Macroeconomic environment4th pillar: Health and primary educationEFFICIENCY ENHANCERS5th pillar: Higher education and training6th pillar: Goods market efficiency7th pillar: Labor market efficiency8th pillar: Financial market development9th pillar: Technological readiness10th pillar: Market sizeINNOVATION AND SOPHISTICATION FACTORS11th pillar: Business sophistication12th pillar: Innovation

Source: The Global Competitiveness Report 2012-2013

Top of the list

Bottom of the list

United States

The most problematic factors for doing business

Note: Respondents were asked to select the five most problematic for doing business in their country and to rank them between 1 (most problematic) and 5. The bars in the figure show the responses weighted according to their rankings.

United States

Trade and Imperfect Competition

• Intra-industry trade • Relevance to international business

– MNEs and assumption of imperfect competition– The concept of competitive advantage

• Grubel-Lloyd index (Box 4.1)

Manufacturing intra-industry trade (% of total man. trade)

Mexico Hungary Germany USA Poland Portugal

1988-1991

1992-1995

1996-2000

Source: see Table 4.1.

Characteristics of intra-industry trade (IIT)1. Horizontally-differentiated trade or vertically differentiated

trade? (problems of aggregation)2. IIT tends to be high in sophisticated manufactured

products.3. IIT levels are high in more open economies.4. IIT levels are high where inward FDI levels are high.

Monopoly Power Concentration ratios: Sum of the market shares of the top

4, 5 or 8 firms. Herfindahl index: sum of the squared market shares of all

firms in the market.

where si is the market share of firm i in the market, and N is the number of firms. Thus, in a market with two firms that each has 50 percent market share, the Herfindahl index is 0.502 + 0.502 = 0.5. A market with 10 firms (with equal shares) will have an index equal to 0.1.

(the possible value of the index is between 1/N and 1)

• Internal increasing returns to scale are the underlying main cause for most international trade models of imperfect competition (Fig. 4.2).

Demand and costs

0 5 10quantity

demand

average costs

marginal costs

marginal revenue

Fig. 4.2© van Marrewijk, 2005

The Trading Equilibrium

Assumption: The foreign firm assumes the home firm will continue to produce the same quantity as in autarky.

The entry of the foreign firm causes the price to fall (increased competition)

Consumers in the home and foreign country gain.

(Fig. 4.3)

Demand and costs

0 5 10quantity

r demand

average costs

marginal costs

initial marginal revenue

mr foreign

national border

Home firm

Foreign firm

Home country

Foreign country

Home sales in Foreign

Foreign sales in Home

national border

Home firm

Foreign firm

Home country

Foreign country

Home sales in Foreign

Foreign sales in Home

1. Climate differences2. Transportation costs (Fig. 4.4)

Alternative explanations for IIT

Fig. 4.4

Strategic interaction between firms: Airbus and Boeing.

Imperfect competition in international business: Fuji versus Kodak (Box 4.3)

2n-3 2n-1

2n-2 2n

varieties in A

varieties in B

2n-3 2n-1

2n-2 2n

varieties in A

varieties in B

Monopolistic competition Love-of-variety effect

Fig. 4.5

Monopolistic competition

Three assumptions (for Fig. 4.6)1. Number of sellers is sufficiently large so

that firms take the price as given.2. Products are heterogeneous.3. Free entry and exit of firms.

Demand and costs

0 5 10quantity

demand

average costs

marginal costs

marginal revenue

Sequence of events (Fig. 4.7)1. Increased competition leads to higher demand elasticity.2. Price falls and the firm has a loss.3. The loss drives some firms out of the market so demand

increases for the remaining firms until zero profits are reached.

4. In the trade equilibrium, the remaining firms produce a larger quantity and lower average cost (internal economies of scale).

5. In the trade equilibrium, consumers benefit from lower prices and larger range of varieties.

6. In the trade equilibrium, the two countries engage in IIT.

Demand and costs

0 5 10quantity

pre-trade demand

average costs

marginal costs

pre-trade mr

post-trade demand

post-trade mr

What does the monopolistic competition model add?

1. Another explanation of IIT (with non-identical products – close substitutes ).

2. The number of suppliers is large but limited.3. The model implies that after trade opens

consumers will also buy varieties from foreign suppliers (leading to IIT)

4. More competition causes the demand curve for individual firms to become more elastic and shift downward. Each firm will produce more and charge a lower price.

IIT: Empirical Evidence IIT between two countries will be high if: per-capita incomes are high differences in levels of development are low the average of the countries’ GDP is high barriers to trade are low the two countries share a common language or border. if the countries are part of a preferential trade agreement

(PTA) the level of product differentiation within sectors is high transaction costs are low trade barriers for the industry are low scale economies are present.

Spring 2013_ECO6705- ch 4

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