On the other hand, innovations that respond to concerns or circumstances that are peculiar to the home market can actually retard international competitive success. The lure of the huge U. Information plays a large role in the process of innovation and improvement—information that either is not available to competitors or that they do not seek.
Sometimes it comes from simple investment in research and development or market research; more often, it comes from effort and from openness and from looking in the right place unencumbered by blinding assumptions or conventional wisdom.
This is why innovators are often outsiders from a different industry or a different country. Innovation may come from a new company, whose founder has a nontraditional background or was simply not appreciated in an older, established company.
Or the capacity for innovation may come into an existing company through senior managers who are new to the particular industry and thus more able to perceive opportunities and more likely to pursue them. Or innovation may occur as a company diversifies, bringing new resources, skills, or perspectives to another industry. Or innovations may come from another nation with different circumstances or different ways of competing.
With few exceptions, innovation is the result of unusual effort. The company that successfully implements a new or better way of competing pursues its approach with dogged determination, often in the face of harsh criticism and tough obstacles. In fact, to succeed, innovation usually requires pressure, necessity, and even adversity: the fear of loss often proves more powerful than the hope of gain.
Once a company achieves competitive advantage through an innovation, it can sustain it only through relentless improvement. Almost any advantage can be imitated. Korean companies have already matched the ability of their Japanese rivals to mass-produce standard color televisions and VCRs; Brazilian companies have assembled technology and designs comparable to Italian competitors in casual leather footwear.
Competitors will eventually and inevitably overtake any company that stops improving and innovating. Sometimes early-mover advantages such as customer relationships, scale economies in existing technologies, or the loyalty of distribution channels are enough to permit a stagnant company to retain its entrenched position for years or even decades.
But sooner or later, more dynamic rivals will find a way to innovate around these advantages or create a better or cheaper way of doing things. Italian appliance producers, which competed successfully on the basis of cost in selling midsize and compact appliances through large retail chains, rested too long on this initial advantage. By developing more differentiated products and creating strong brand franchises, German competitors have begun to gain ground. Ultimately, the only way to sustain a competitive advantage is to upgrade it— to move to more sophisticated types.
This is precisely what Japanese auto-makers have done. They initially penetrated foreign markets with small, inexpensive compact cars of adequate quality and competed on the basis of lower labor costs. Even while their labor-cost advantage persisted, however, the Japanese companies were upgrading. They invested aggressively to build large modern plants to reap economies of scale. Then they became innovators in process technology, pioneering just-in-time production and a host of other quality and productivity practices.
These process improvements led to better product quality, better repair records, and better customer-satisfaction ratings than foreign competitors had. The example of the Japanese automakers also illustrates two additional prerequisites for sustaining competitive advantage. First, a company must adopt a global approach to strategy.
It must sell its product worldwide, under its own brand name, through international marketing channels that it controls. Second, creating more sustainable advantages often means that a company must make its existing advantage obsolete—even while it is still an advantage. Japanese auto companies recognized this; either they would make their advantage obsolete, or a competitor would do it for them.
As this example suggests, innovation and change are inextricably tied together. But change is an unnatural act, particularly in successful companies; powerful forces are at work to avoid and defeat it. Past approaches become institutionalized in standard operating procedures and management controls. Training emphasizes the one correct way to do anything; the construction of specialized, dedicated facilities solidifies past practice into expensive brick and mortar; the existing strategy takes on an aura of invincibility and becomes rooted in the company culture.
Successful companies tend to develop a bias for predictability and stability; they work on defending what they have. Change is tempered by the fear that there is much to lose. The organization at all levels filters out information that would suggest new approaches, modifications, or departures from the norm.
Innovation ceases; the company becomes stagnant; it is only a matter of time before aggressive competitors overtake it. Why are certain companies based in certain nations capable of consistent innovation? Why do they ruthlessly pursue improvements, seeking an ever more sophisticated source of competitive advantage? Why are they able to overcome the substantial barriers to change and innovation that so often accompany success?
The answer lies in four broad attributes of a nation, attributes that individually and as a system constitute the diamond of national advantage, the playing field that each nation establishes and operates for its industries. These attributes are.
Factor Conditions. Demand Conditions. Related and Supporting Industries. The presence or absence in the nation of supplier industries and other related industries that are internationally competitive.
Firm Strategy, Structure, and Rivalry. The conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry. These determinants create the national environment in which companies are born and learn how to compete. Sophisticated and demanding local buyers, strong and unique distribution channels, and intense rivalry among local companies created constant pressure for innovation.
Knowledge grew quickly from continuous experimentation and cumulative production experience. Private ownership of the companies and loyalty to the community spawned intense commitment to invest in the industry. Tile producers benefited as well from a highly developed set of local machinery suppliers and other supporting industries, producing materials, services, and infrastructure. The presence of world-class, Italian-related industries also reinforced Italian strength in tiles. Finally, the geographic concentration of the entire cluster supercharged the whole process.
Today foreign companies compete against an entire subculture. Tile production in Sassuolo grew out of the earthen-ware and crockery industry, whose history traces back to the thirteenth century. Immediately after World War II, there were only a handful of ceramic tile manufacturers in and around Sassuolo, all serving the local market exclusively. Demand for ceramic tiles within Italy began to grow dramatically in the immediate postwar years, as the reconstruction of Italy triggered a boom in building materials of all kinds.
Italian demand for ceramic tiles was particularly great due to the climate, local tastes, and building techniques.
Because Sassuolo was in a relatively prosperous part of Italy, there were many who could combine the modest amount of capital and necessary organizational skills to start a tile company. In , there were 14 Sassuolo area tile companies; by , there were The new tile companies benefited from a local pool of mechanically trained workers.
The region around Sassuolo was home to Ferrari, Maserati, Lamborghini, and other technically sophisticated companies. As the tile industry began to grow and prosper, many engineers and skilled workers gravitated to the successful companies. Initially, Italian tile producers were dependent on foreign sources of raw materials and production technology. In the s, the principal raw materials used to make tiles were kaolin white clays.
Since there were red- but no white-clay deposits near Sassuolo, Italian producers had to import the clays from the United Kingdom. Tile-making equipment was also imported in the s and s: kilns from Germany, America, and France; presses for forming tiles from Germany.
Sassuolo tile makers had to import even simple glazing machines. Over time, the Italian tile producers learned how to modify imported equipment to fit local circumstances: red versus white clays, natural gas versus heavy oil. As process technicians from tile companies left to start their own equipment companies, a local machinery industry arose in Sassuolo.
By , Italian companies had emerged as world-class producers of kilns and presses; the earlier situation had exactly reversed: they were exporting their red-clay equipment for foreigners to use with white clays.
The relationship between Italian tile and equipment manufacturers was a mutually supporting one, made even more so by close proximity. The equipment manufacturers competed fiercely for local business, and tile manufacturers benefited from better prices and more advanced equipment than their foreign rivals. As the emerging tile cluster grew and concentrated in the Sassuolo region, a pool of skilled workers and technicians developed, including engineers, production specialists, maintenance workers, service technicians, and design personnel.
An array of small, specialized consulting companies emerged to give advice to tile producers on plant design, logistics, and commercial, advertising, and fiscal matters. With its membership concentrated in the Sassuolo area, Assopiastrelle, the ceramic tile industry association, began offering services in areas of common interest: bulk purchasing, foreign-market research, and consulting on fiscal and legal matters. The growing tile cluster stimulated the formation of a new, specialized factor-creating institution: in , a consortium of the University of Bologna, regional agencies, and the ceramic industry association founded the Centro Ceramico di Bologna, which conducted process research and product analysis.
By the mids, per-capita tile consumption in Italy was considerably higher than in the rest of the world. Italian customers, who were generally the first to adopt new designs and features, and Italian producers, who constantly innovated to improve manufacturing methods and create new designs, progressed in a mutually reinforcing process.
The uniquely sophisticated character of domestic demand also extended to retail outlets. In the s, specialized tile showrooms began opening in Italy. In , the Italian company Piemme introduced tiles by famous designers to gain distribution outlets and to build brand name awareness among consumers.
The sheer number of tile companies in the Sassuolo area created intense rivalry. News of product and process innovations spread rapidly, and companies seeking technological, design, and distribution leadership had to improve constantly. Proximity added a personal note to the intense rivalry. All of the producers were privately held, most were family run. The owners all lived in the same area, knew each other, and were the leading citizens of the same towns.
In the early s, faced with intense domestic rivalry, pressure from retail customers, and the shock of the energy crisis, Italian tile companies struggled to reduce gas and labor costs. These efforts led to a technological breakthrough, the rapid single-firing process, in which the hardening process, material transformation, and glaze-fixing all occurred in one pass through the kiln.
A process that took employees using the double-firing method needed only 90 employees using single-firing roller kilns. Cycle time dropped from 16 to 20 hours to only 50 to 55 minutes. The new, smaller, and lighter equipment was also easier to export. Working together, tile manufacturers and equipment manufacturers made the next important breakthrough during the mid-and late s: the development of materials-handling equipment that transformed tile manufacture from a batch process to a continuous process.
The innovation reduced high labor costs—which had been a substantial selective factor disadvantage facing Italian tile manufacturers. The common perception is that Italian labor costs were lower during this period than those in the United States and Germany. In those two countries, however, different jobs had widely different wages.
In Italy, wages for different skill categories were compressed, and work rules constrained manufacturers from using overtime or multiple shifts. The restriction proved costly: once cool, kilns are expensive to reheat and are best run continuously. Because of this factor disadvantage, the Italian companies were the first to develop continuous, automated production. By , Italian domestic demand had matured. The stagnant Italian market led companies to step up their efforts to pursue foreign markets.
The presence of related and supporting Italian industries helped in the export drive. Individual tile manufacturers began advertising in Italian and foreign home-design and architectural magazines, publications with wide global circulation among architects, designers, and consumers. This heightened awareness reinforced the quality image of Italian tiles. Assopiastrelle, the industry association, established trade-promotion offices in the United States in , in Germany in , and in France in It organized elaborate trade shows in cities ranging from Bologna to Miami and ran sophisticated advertising.
When a national environment permits and supports the most rapid accumulation of specialized assets and skills—sometimes simply because of greater effort and commitment—companies gain a competitive advantage. When a national environment affords better ongoing information and insight into product and process needs, companies gain a competitive advantage. Finally, when the national environment pressures companies to innovate and invest, companies both gain a competitive advantage and upgrade those advantages over time.
According to standard economic theory, factors of production—labor, land, natural resources, capital, infrastructure—will determine the flow of trade. A nation will export those goods that make most use of the factors with which it is relatively well endowed.
This doctrine, whose origins date back to Adam Smith and David Ricardo and that is embedded in classical economics, is at best incomplete and at worst incorrect. In the sophisticated industries that form the backbone of any advanced economy, a nation does not inherit but instead creates the most important factors of production—such as skilled human resources or a scientific base.
Moreover, the stock of factors that a nation enjoys at a particular time is less important than the rate and efficiency with which it creates, upgrades, and deploys them in particular industries. The most important factors of production are those that involve sustained and heavy investment and are specialized.
Basic factors, such as a pool of labor or a local raw-material source, do not constitute an advantage in knowledge-intensive industries. Companies can access them easily through a global strategy or circumvent them through technology.
Contrary to conventional wisdom, simply having a general work force that is high school or even college educated represents no competitive advantage in modern international competition. These factors are more scarce, more difficult for foreign competitors to imitate—and they require sustained investment to create.
Nations succeed in industries where they are particularly good at factor creation. Competitive advantage results from the presence of world-class institutions that first create specialized factors and then continually work to upgrade them.
Denmark has two hospitals that concentrate in studying and treating diabetes—and a world-leading export position in insulin. What is not so obvious, however, is that selective disadvantages in the more basic factors can prod a company to innovate and upgrade—a disadvantage in a static model of competition can become an advantage in a dynamic one.
When there is an ample supply of cheap raw materials or abundant labor, companies can simply rest on these advantages and often deploy them inefficiently. The WTO is a table. People sit round the table and negotiate. What do you expect the table to do? Simply put:. A tree for site navigation will open here if you enable JavaScript in your browser. Born in , but not so young back to top The WTO began life on 1 January , but its trading system is half a century older.
Free trade is an opportunity to open another part of the world to domestic producers. Moreover, free trade is now an integral part of the financial system and the investing world. American investors now have access to most foreign financial markets and to a wider range of securities, currencies, and other financial products.
However, completely free trade in the financial markets is unlikely in our times. The European Union is a notable example of free trade today. The member nations form an essentially borderless single entity for the purposes of trade, and the adoption of the euro by most of those nations smooths the way further.
It should be noted that this system is regulated by a bureaucracy based in Brussels that must manage the many trade-related issues that come up between representatives of member nations. The United States currently has a number of free trade agreements in place. There are also separate trade agreements with nations from Australia to Peru. Collectively, these agreements mean that about half of all goods entering the U.
All these agreements collectively still do not add up to free trade in its most laissez-faire form. Amerian special interest groups have successfully lobbied to impose trade restrictions on hundreds of imports including steel, sugar, automobiles, milk, tuna, beef, and denim. David Ricardo. Murray, Kansas State University. Customs and Border Protection. Office of the United States Trade Representative.
Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. This in turn means that standard trade statistics have limitations in how useful they are for understanding what is really happening in world trade. Traditional economic theory assumed that goods are traded between countries, but that factors of production e. However, recently capital, technology, and services have been increasingly flowing easily over national borders, and even labor is moving from country to country more frequently.
Accordingly, in recent rounds of multilateral negotiations and in U. In economic theory, if factors of production are fully mobile, the costs of all factors of production that could move across borders would result in equal costs in all trading countries. This would mean that the basis of comparative advantage for trade between countries would diminish and there would ultimately be less international trade. In reality, of course, there are reasons other than trade barriers why factors of production such as capital or labor may not move across borders, even when there are no barriers and higher returns could be gained in other markets.
Workers, for example, are reluctant to leave their homelands and family and friends, and investors are reluctant to invest in other markets where they have less familiarity. As a result, even eliminating all governmentally imposed barriers to trade in capital and labor would not lead to the complete equalization of costs between counties.
Like trade in investment and capital, post—World War II economists did not conceive of trade in services. In fact, trade in services was almost considered an oxymoron by early economists, such as Adam Smith and David Ricardo, who assumed that services are not tradable.
This was also the view of trade negotiators for three or more decades after the GATT was launched. Geza Feketukuty, the lead U. The chairman of the committee. Not surprisingly, economic theory as it applies to services trade is still being developed.
In general, economists today assume that the basic theory of comparative advantage as it applies to goods applies equally well to cross-border trade in services. Many types of services, such as telecommunications, are intimately interconnected to other economic activity. Trade liberalization in these areas can have far-reaching economic effects. For example, lowering the costs and increasing the availability of telecommunications services can help manufacturers compete in global markets, it can enable farmers to learn the latest techniques, and it can help other services sectors, such as tourism, that can now reach the world market through the Internet.
In contrast, liberalizing restrictions in some other sectors, such as tourism, may affect revenues and employment for the providers and the country but will have only a minimal impact on the competitiveness of other sectors within the country.
In other words, the liberalization of some services may have multiplier effects throughout the economy, whereas in other sectors the benefits will largely flow only to the affected sector. The classic Western model of trade was based on eighteenth-century economic realities. Factors of production were relatively fixed: Land was immobile although its fertility or usage might change , and labor mobility was highly restricted by political constraints.
For most of the century, the movement of capital across borders was limited by political barriers and a lack of knowledge of other markets. However, by the middle of the nineteenth century both capital and labor were flowing more freely between Europe and the Americas. Additionally, the production of most products at that time was subject to diminishing returns, which meant that as production increased, the costs of producing each additional unit increased. In this world, the classic Ricardian model of trade provided a good explanation for trade patterns, such as which countries would produce what products.
England would produce textiles based on its wool production and capital availability, and Portugal would produce wine based on its sunshine and fertile soil. However, the world economy began to change in the twentieth century, as some products could be produced under conditions of increasing returns to scale.
As a company produced more steel, production could be automated and the costs of each additional unit could be significantly reduced. And the same was true for automobiles and a growing number of other more sophisticated products. By the last twenty-five years of the twentieth century, the global economy was significantly different. Land and labor were still relatively fixed, although capital could again move more freely around the world.
However, technology was highly differentiated among countries, with the United States leading in many areas. An established company in an industry that required extensive capital investment and knowledge had an enormous advantage over potential competitors. Its production runs were large, enabling it to produce product at low marginal cost. And the capital investment for a new competitor would be large. In this new world, the economic policies pursued by a nation could create a new comparative advantage.
A country could promote education and change its labor force from unskilled to semiskilled or even highly skilled. Or it could provide subsidies for research and development to create new technologies. Or it could take policy actions to force transfer of technology or capital from another country, such as allowing its companies to pirate technology from competitors or imposing a requirement that foreign investors transfer technology.
The underlying reason for these significant departures from the original model is that the modern free-trade world is so different from the original historical setting of the free trade models. Today there is no one uniquely determined best economic outcome based on natural national advantages.
Rather, there are many possible outcomes that depend on what countries actually choose to do, what capabilities, natural or human-made, they actually develop. In the world of the late twentieth century, a country might be dominant in an industry because of its innate comparative advantage, or it might be dominant because of a strong boost from government policy, or it might be dominant because of historical accident.
For example, the U. The capital costs of entry may be very large, and it is difficult for a new entrant to master the technology. Additionally, the industry normally has a web of suppliers that are critical to competitiveness, such as steel companies and tire manufacturers.
However, if such an industry losses its dominance, it is equally difficult for it to reenter the market. A country with such a dominant industry benefits enormously economically. Because of its dominant position, such an industry may pay high wages and provide a stable base of employment. Access to other markets plays an important role in this economic model where comparative advantage can be created. Without free trade, it becomes extremely costly for a government to subsidize a new entrant because the subsidy must be large enough both to overcome foreign trade barriers and to jump-start the domestic producer.
Some of these outcomes are good for one country, some are good for the other, some are good for both. But it often is true that the outcomes that are the very best for one country tend to be poor outcomes for its trading partner. Although country policies can lead to creation of a dominant industry, such an industry may not be as efficient as if it had occurred in another country.
This example is less valid today, as China has become a major steel producer. Although there are many areas where government policies can create comparative advantage, there are still many areas where the classic assumptions of an inherent comparative advantage still hold.
The key is whether the industry is subject to constant or increasing costs, such as wheat, or decreasing costs, such as autos, aircraft, or semiconductors. The doctrine of mercantilism, which dominated thinking up to the end of the eighteenth century, is generally rejected by Western economists today. However, a number of countries—including Japan, South Korea, China, and some other countries in the Far East—have pursued a neomercantilism model in which they seek to grow through an aggressive expansion of exports, coupled with a very measured reduction of import barriers.
These countries seek to develop powerful export industries by initially protecting their domestic industry from foreign competition and providing subsidies and other support to stimulate growth, often including currency manipulation. The success of some countries pursuing a neomercantilist strategy does not refute the law of comparative advantage. In fact, the reason these countries are successful is that they focus on industries where they have or can create a comparative advantage.
Thus Japan first focused on industries such as steel and autos, and later on electronics, where a policy of import protection and domestic subsidies could enable their domestic firms to compete in world markets, and particularly the U. Neomercantilists generally focus on key industries selected by government, a strategy known as industrial policy.
A successful industrial policy requires a farsighted government. Japan had an extremely competent group of government officials in the Ministry of Industry and Trade MITI , which oversaw its industrial policy and was basically immune from political pressures. Although MITI had many successes, it also made some missteps. For example, in their planning to develop a world-class auto industry in the s, MITI officials initially believed they had too many auto companies, and urged Honda to merge with another company.
Instead, Honda elected to invest in the United States and went on to become a leading auto producer. Countries pursuing the neomercantilist model have also generally promoted education and high domestic savings to finance their growing export industries. By contrast, the U. Many economists argue that a neomercantilist strategy may be successful for a while but that over time such a strategy will not be effective. Basically this argument is that the complexities for governments in picking potential winners and identifying how to promote those industries are too great.
For example, Japan was very successful with its neomercantilist strategy until the mids. However, since then the Japanese economy has been stagnating, and many economists believe that Japan will need to change its approach to stimulating domestic demand rather than focusing on export markets.
During the past ten years, South Korea and China have also pursued neomercantilist policies, and it remains to be seen if these are effective over the long term. Additionally, a number of economists argue that government intervention can be effective in promoting a specific sector but that industrial policies are not effective at the macro level of benefiting the economy as a whole.
In any case, Western economists and policymakers today almost universally reject the idea that the United States should adopt an industrial policy that picks winners and losers. Opponents of a possible U. Instead, the real debate among economists and policymakers is whether the United States should respond to foreign neomercantilist practices, and if so, how. Stephen Cohen and his colleagues say:.