Sources of comparative advantage

1. Sources of comparative advantage • Objectives of this lecture • Show how factor abundance gives rise to comparative advantage • Identify sources of superior factor quality. • Show how changing factor intensities shifts comparative advantages over time.

2. Factor Proportions Theory • Countries will be net exporters of products that use their relatively abundant factors intensively. • The statement about trade has implications for the location of production of particular goods. • To understand this proposition, we need to define factors, factor abundance, and intensive use.

3. Factors and Products: What’s the difference? • Products: goods and services • Tradeable (in most cases) • Made from intermediate inputs (i.e. non-final products) and factors. • Factors of production: things that create products and earn incomes for their owners, namely labour (L) and capital (K). • Not mobile across countries (in most cases) • Not incorporated into the products they make, a single factor makes a stream of products.

4. 5 Kinds of Capital • Physical capital: machinery and buildings • Intellectual capital: patents, brands, etc. • Human capital: education and experience • Social capital: associations and relations • Natural capital: land and sub-soil resources.

5. Factor Abundance is Relative! • 2 country, 2 factor calculations: • Home is capital abundant when home’s K/L ratio is larger than the K/L ratio in the foreign country. • Relativity: K-abundance at home implies L-scarcity. • Multi-factor, world-wide calculations: • Home is abundant in factor F when home’s share of the world supply of factor F exceeds home’s share of world income (GDP).

6. Factor Abundance in Three Countries

7. Example: Crop Land • US has “absolute” abundance compared to Canada because 187.8 m hec > 45.5 m hec • If the second factor is labour, then Canada is relatively abundant since 45.5/15 > 188/136. • Considering the world, Canada is cropland abundant because its share of world crops, 3%, exceeds its share of world income, 2%. • US appears crop-land scarce since 13%<26%.

8. Factor Intensity • The relative importance of one factor versus others in production in an industry, usually compared across industries. • Measured as share of value-added going to a particular factor (so excludes intermediate good inputs).

9. Factor Intensity in Manufacturing Industries

10. Factor Advantage as matching • Factor advantage is a “matching” process. • Choose the right country for each product • “Intensive user seeks abundant factor” • Absolute abundance is not enough: • Bigger isn’t better • Proportions are the key.

11. US$b 2004 Canada China France Japan Italy Mexico India UK USA

12. Revealed comparative advantage • Defined as a country's share of world exports of a good divided by its share of total world exports. • Country i’s RCA in product j is • RCAij = 100(Xij/Xwj)/(Xit/Xwt) • where w=world t=total for all goods. • RCAs greater than 100 indicate revealed comparative advantage

13. RCA, 2004

14. Michael Porter’s Critique of FABCA • Traditional factor abundance won’t lead to sustained competitive advantage. • Need a distinctive, inimitable advantage • Need something that cannot be substituted for. • Competitive advantage in core firm activities arises from industry clusters that foster development of advanced, specialized factors.

15. Types of Factors

16. Examples of Different Factor Types • Type I (basic, general use) • Unskilled labour, pasture land • Type II (advanced, general use) • Bachelor degrees, power transmission grid • Type III (specific, basic) • Oil well ( specific to petro-refining industry) • Type IV (specific, advanced) • UC Davis enology dept., Danish diabetes treatment centres.

17. Selective factor disadvantage • A selective factor disadvantage (SFD) is the absence of a basic factor that would be advantageous to have in abundance if there were no dynamic effects. An SFD can stimulate innovation which more than compensates for the original disadvantage. SFDs are best when they send an accurate signal about circumstances that will ultimately prevail elsewhere. • Switzerland: first country to experience labour shortage. Abandoned labour intensive watches and concentrated on innovative and/or high-end watches (Rolex, Swatch). • Japan: high priced land led to a high cost of factory space which led to development of the J.I.T. system. • Sweden: A short building season plus high construction costs led to development of pre-fabricated housing.

18. International Product Life Cycles • Product produced and consumed in the (advanced) inventing country. Other advanced countries import it. • Production spreads to other advanced countries. • Production re-locates out of advanced countries into a low-wage nation. Advanced countries become importers • Next generation product invented.

19. International Product Life Cycles

20. Example: photocopiers STAGE I: New product • 1938: invented by Chester Carlson in Queens, NYC • 1949: First “xerographic” copier introduced by Haloid Company (later Xerox) • 1953: Sales subsidiary established in Canada.

21. Example: photocopiers STAGE II: Maturing product • 1956: Rank-Xerox joint venture established in UK. • 1962: Fuji-Xerox joint venture established in Japan. • 1965: Rank-Xerox opens manufacturing plant in the Netherlands. • 1974: Rank Xerox opens factories in Spain and France. • Various: Other companies such as Canon (Japan) and Olivetti (Italy) introduce photocopiers

22. Example: Photocopiers Stage III: Standardization • 1965: Xerox do Brasil founded (3 factories) • 1987: Xerox Shanghai J.V. formed to make copiers in China. • 1988: 2,000,000th Xerox copier is produced. • 1993: Xerox do Brasil Ltda. wins National Quality Award in Brazil. • 2000: all Asian operations sold to Fuji-Xerox.

23. Canadian Imports of Photocopiers

24. US Imports of Photocopiers

25. Understanding IPLCs • What causes the move from stage I to stage II? That is why does production spread to other advanced countries? • Inventing firm wants production closer to consumers • Rival firms license or imitate or wait for patent expiration

26. Understanding IPLCs • What causes the move from stage II to stage III? That is why does production relocate to less developed countries? • Dubious answer: competition “forces” inventing firms to seek low costs. • Good answer: standardization changes factor intensities, skilled-labour intensity falls as manufacturing process is “routinized” • Other explanations: Initially need to have production close to customers and HQs

27. “Textile Entrepreneurs Thriving on Free Trade” • What developments changed the business environment of Canadian textile makers in the 1990s? Were these developments good or bad? • What actions have been taken by makers who have chosen “to retreat”? • What actions have been taken by makers who have chosen “to fight”? • What happened to the Canada-U.S. textile trade balance from 1988-1996?

28. “Is Your Job Safe?” • What are the top countries in terms of offshore location attractiveness in IT according to A.T. Kearney’s 2004 index? Where did Canada place? • What is “near-shoring” and how does this affect jobs in Canada? Why is it useful to operate near to the target market? • How have exchange rate movements affected Canadian competitiveness. • What is the IT food chain? What types of tasks are at the top and at the bottom of this food chain? • Can moving jobs to India create new jobs in Canada?

29. “Globalization: It’s Not Just Wages” • How did Whirlpool enter the front-loader washing machine industry? Why enter this way? • Consider Whirlpool’s different production locations for washing machines. • Explain the logic of each production location.