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Comparative Vs Competitive Advantage
Comparative Vs Competitive Advantage
Introduction
The major aim of this paper is to establish a link between the principles of
comparative and competitive advantage, and outline a synthesis of the two principles as
a guiding force for gauging success of nations and/or firms in international
trade/business. In the next two sections of the paper, we review the theories of
comparative advantage and competitive advantage. In section 4, we outline a synthesis
of the models. Section 5 concludes the paper with some suggestions for further
research in this area.
II. Absolute and Comparative Advantage
The literature on international trade and policy contains a number of reasons why
a country may have an advantage in exporting a commodity to another country. For
convenience, most of these reasons may be classified into (1) technological superiority,
(2) resource endowments, (3) demand patterns, and (4) commercial policies.
Technological Superiority
Adam Smith’s principle of “absolute advantage” and David Ricardo’s principle of
“comparative advantage”, in general, are based on the technological superiority of one
country over another country in producing a commodity. Absolute advantage refers to a
country having higher (absolute) productivity or lower cost in producing a commodity
compared to another country. However, absolute advantage in the production of a
commodity is neither necessary nor sufficient for mutually beneficial trade. For example,
a country may be experiencing absolute disadvantage in the production of all
commodities compared to another country, yet the country may derive benefits by
engaging in international trade with other countries, due to relative (comparative)
advantage in the production of some commodities vis-à-vis other countries. Likewise,
absolute advantage in the production of a commodity is not sufficient, since the country
may not have relative (comparative) advantage in the production of that commodity.
David Ricardo’s principle of comparative advantage does not require a higher absolute
productivity but only a higher relative productivity (a weaker assumption) in producing a
commodity. Pre-trade relative productivities/costs determine the pre-trade relative
prices. Pre-trade relative prices in each country determine the range of possible terms
of trade for the trading partners. Actual terms of trade within this range, in general,
depend on demand patterns, which, in turn determines the gains from trade for each
trading partner.
The Ricardian model assumes constant productivity, as there is only one factor
of production (labour), and therefore constant (opportunity) costs that leads to complete
specialization. However, increasing opportunity costs that often arise in multi-factor
situations (law of diminishing returns) due to limited quantity of some factors specific to
an industry can easily be accommodated to allow for incomplete specialization. Thus, in
the Ricardian model, technological differences in two countries are the major source of
movement of commodities across national boundaries.
Resource Endowments
Availability of resources in a country provides another source of comparative
advantage for countries that do not necessarily possess a superior technology. Under
certain restrictive assumptions, comparative advantage can be obtained due to
differences in relative factor endowments. As propounded by Heccksher and Ohlin, a
country has a comparative advantage in the production of that commodity which uses
the relatively abundant resource in that country more intensively. For example,
newsprint uses natural resources (forest products) more intensively compared to
textiles. Textiles use labour (L) more intensively compared to newsprint. Canada is
relatively abundant in natural resources (R) compared to India. (R/L) Canada > (R/L)
India. This implies R will be relatively cheaper in Canada as compared to India. Thus,
Canada has a comparative advantage in newsprint and will therefore specialize and
export newsprint to India. Likewise, India has a comparative advantage in textiles and
will therefore specialize and export textiles to Canada.
Human skills: Human skills can also be considered a resource. Countries with
relatively abundant human skills will have a comparative advantage in products that use
human skills more intensively. Certain products such as electronics require a highly
skilled labour force (such as engineers, programmers, designers, and other professional
personnel). Such products may gain comparative advantage in countries (such as
Taiwan, Singapore, Hong Kong) that are relatively better endowed with such skilled
labour. (Keesing, 1966). Government policies aimed at better education and training
can create such an endowment.
The role of demand and the size of the home market for products are already
evident in (1) establishing the equilibrium terms of trade and therefore the division of
gains from trade; (2) economies of scale; and (3) product cycle hypothesis. In addition,
Linder (1961) emphasized the role of demand in the home market as a stepping stone
towards success in international markets. According to Linder, manufacturers initiate the
production of a new product to satisfy the local market. In this step, they learn the
necessary skills for making the product by more efficient techniques, which in turn, give
these nations comparative advantage in the product vis-à-vis other countries. Linder’s
thesis postulates exporting the product to countries with similar tastes/demand patterns.
The theory, coupled with market imperfections and product differentiation can explain a
large portion of intra-industry trade among the industrialized nations.
What exactly is competitive advantage, and how does it differ from comparative
advantage? In a recent article Peer Neary (2003), attempting to advance the theory of
comparative advantage in the presence of market imperfections (oligopoly in a general
equilibrium framework) had to say the following for a general understanding of
competitive advantage in the economics profession.
“Comparative advantage is widely believed by economists to be a key
determinant of international production and trade patterns. But non-economists typically
think otherwise. In business schools and business circles much greater emphasis is
placed on the role of competitive advantage as a predictor of the economic fortunes not
just of firms, but nation as a whole.
What exactly is competitive advantage? And how, if at all, does it relate to and
interact with comparative advantage? One possible answer is that it is something to do
with more competitive markets: lower barriers to entry or simply a large number of firms
may give an industry an advantage in competing with foreign rivals. A different answer
is that competitive advantage is just a synonym for absolute advantage: some natural or
policy-induced superiority (such as lower taxes or greater labour market flexibility) which
reduces costs for all home sectors.….A different approach to understanding competitive
advantage, exemplified by Porter (1990), is to use a case-study evidence to identify the
factors, which encourage a nation’s firms to achieve high world market shares in their
industries. For the most part, economists have either ignored Porter’s approach or
dismissed it as merely a restatement of comparative advantage (see Warr, 1994).”
Competencies/Resources to benefit
from Comparative Advantage and
convert it in to Competitive Advantage
Business Environment/
Government policies/
Supporting industries
Factor conditions do not refer to the conventional pool of resources, such as
land, labour, capital, raw materials, but rather those “created” and continually upgraded
such as highly specialised skilled labour, and world-class scientific institutions most
suited to the industry’s needs. The Demand conditions refer to, not the size, but the
character of home market demand--the sophisticated and demanding buyers who can
signal the future pattern of demand and can pressure the companies to innovate faster
compared to competitors elsewhere. Related and supporting industries that are
internationally competitive, and in particular, actively engaged in innovation and
upgrading are more promising in creating competitive advantage rather than the mere
existence of raw material and/or component producing industries. Firm strategies,
structure and rivalry refer to managerial, organizational as well as the existence of
competitive forces/challenges from other firms within the industry. While the
managerial/organizational modes must be compatible with other sources of competitive
advantage, existence of domestic rivalry is considered sine-qua-non as well as an
integrating force in the “diamond”. It forces companies to a continual challenge for
innovation and upgrading in all forces in the “diamond” and makes the working of the
diamond as a system in gaining and sustaining competitive advantage. Porter presents
these forces in the form of a “diamond” depicted in Figure 2 (adapted from
Porter,1990a).
As is obvious from the description and operation of the forces in the “diamond”,
the competitive advantage of an industry is driven by firm-specific factors, the
competitive environment, and the push towards innovation and up-grading. The basic
differences in the framework of competitive advantage vis-à-vis factors influencing
comparative advantage are (1) an emphasis on “created” factors of production and
innovation by the firms in competitive advantage versus the “inherited” factors of
production and technology with dynamic elements at the national level; (2) an emphasis
on demand side, particularly firm’s success in creating a differentiated product with
some unique characteristics within the same industry in competitive advantage versus
market size for products of each industry in comparative advantage; (3) an emphasis
on gaining monopoly or niche by successful firms in markets for their products in
competitive advantage versus emphasis on traditional models of competition in
comparative advantage; and (4) an emphasis on explaining intra-industry trade in
advanced industrialised economies in competitive advantage versus inter-industry trade
in comparative advantage. Thus, in general, the competitive advantage framework
relies on the “bottom-up” approach to competitive advantage of a nation as compared to
the “top-down” approach in the models of comparative advantage. What we need is a
synthesis of the two frameworks for a better explanation of international trade in all good
and services.
Competencies/Resources to benefit
from Comparative Advantage and
convert it in to Competitive Advantage
Business Environment/
Government policies/
Supporting industries
diamond) are stronger compared to the firm level forces. Further, the same country may
gain advantage in intra-industry trade with some countries as well as inter-industry trade
with some other countries.
Strength of the feedback from the firm level forces to the country level forces
depends on the strength of R&D and innovation strategies (relating to both demand and
supply sides) carried out by the firms and national competition policy. The strength of
the feedback from the country level forces to the firm level forces depends on the
differences in factor endowments and technology between countries, the degree of
national involvement in infrastructure, skill training, and the macro policies suitable for
international trade and investment. In general, we believe, in a static world, a country
and the firms in that country will enjoy competitive advantage if firms in that country
specialize in the products in which a country has a comparative advantage. In a
dynamic world, firms will find it to their benefit to enhance comparative advantage of
their nations through forces of competitive advantage, where created factors and
cutting-edge technology and innovation assume greater importance. The
competitiveness of nations measured by organizations such as the World Economic
Forum and the International Institute of Management Development, though not suitable
for our purpose, use both micro and macro variables.
V. Concluding Remarks
In this paper, we identified the major forces influencing both comparative and
competitive advantage in the form of two separate “diamonds”/frameworks. Both
diamonds were then linked to offer a better explanation of the competitive advantage of
nations. Forces in the comparative advantage diamond are seen to influence forces in
the competitive advantage diamond and vice versa. In our view, pursuing the forces
related to competitive advantage in those goods and services in which a nation already
has some comparative advantage offers a better promise for success in gaining
competitive advantage for the nation. In this “double diamond” framework, it is also
possible for forces of competitive advantage to further strengthen the operation of the
forces of comparative advantage or even help create comparative advantage in goods
and services, hitherto not available based solely on classical theories of comparative
advantage. In general, this paper views competitive advantage and comparative
advantage as supplements rather than substitutes in determining and sustaining a
nation’s advantage in international trade and business. However, more research needs
to be done to crystallise these ideas in a more refined framework, and to provide a solid
empirical foundation for these ideas.
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