Instead of enhance the country’s competitive advantage.7

The quality of human resources is a function of human development. The United Nations Develop- ment Program has prepared the Human Devel- opment Index (HDI) to measure well-being.⁸ The HDI, ranging from zero (low human development) to one (high human development), is an arithmetic average of a country’s achievements in three basic dimensions: longevity (measured by life expectancy

at birth); educational attainment (measured by com- bination of adult literacy rate and enrollment ratio in primary, secondary, and tertiary education); and living standards (measured by GDP per capita in US dollars at purchasing power parity). Both the HDI and per capita income are highly correlated with the other widely used measures of poverty. Table 2.5 shows a list of countries based on the HDI.

The competitive advantage of nations

Michael Porter’s book, The Competitive Advantage of Nations, has received a great deal of interest all over the world.⁹ Based on his analysis of over a hundred case studies of industries in ten leading developed nations, Porter has identified four major determi-

Table 2.5 Human Development Index (HDI), selected countries

≤ 0.50	0.51–0.70	0.71–0.80	> 0.80
Africa	Africa	Asia	Europe/Industrial
Sudan (0.48)	South Africa (0.70)	Thailand (0.74)	Canada (0.93)
Mauritania (0.45)	Botswana (0.59)	Philippines (0.74)	USA (0.93)
Nigeria (0.44)	Gabon (0.59)	China (0.71)	Australia (0.93)
Congo, Dem. Rep. of	Ghana (0.56)		Japan (0.92)
the (0.43) Zimbabwe (0.56) Transition economies United Kingdom (0.92)
Zambia (0.42)	Cameroon (0.53)	Bulgaria (0.77)	France (0.92)
Cote d’lvoire (0.42)	Kenya (0.51)	Russia (0.77)	Germany (0.91)
Senegal (0.42)	Congo, Rep. of (0.51)	Romania (0.77)	Italy (0.90)
Tanzania (0.41)		Georgia (0.76)	Spain (0.90)
Uganda (0.41)	Asia	Ukraine (0.74)
Angola (0.40)	Vietnam (0.67)	Azerbaijan (0.72)	Asia
Malawi (0.38)	Indonesia (0.67)	Albania (0.71)	Singapore (0.88)
Mozambique (0.34)	India (0.56)		Hong Kong SAR (0.87)
Ethiopia (0.31)	Pakistan (0.52)	Middle East	Korea, Rep. of (0.85)
Niger (0.29)		Saudi Arabia (0.75)
Sierra Leone (0.25)	Transition economies	Jordan (0.72)	Transition economies
	Moldova (0.70)	Iran, Islamic Rep. of	Czech Republic (0.84)
Asia	Uzbekistan (0.69)	(0.71)	Hungary (0.82)
Lao People’s Dem.	Tajikistan (0.66)		Poland (0.81)
Rep. (0.48) Western Hemisphere
Nepal (0.47)	Middle East	Mexico (0.78)	Middle East
Bangladesh (0.46)	Syrian Arab Republic	Colombia (0.76)	Israel (0.88)
(0.66) Brazil (0.75) Kuwait (0.84)

Middle East Egypt (0.62) Peru (0.74)

Yemen (0.45) Iraq (0.58) Western Hemisphere

Argentina (0.84)

Western Hemisphere Western Hemisphere Chile (0.83) Haiti (0.44) Bolivia (0.64) Uruguay (0.82)

Nicaragua (0.63) Guatemala (0.62)

Source: Paul Cashin, Paolo Mauro, and Ratna Sahay, “Macroeconomic Policies and Poverty Reduction: Some Cross-Country

Evidence,” Finance & Development, June 2001, 46–9.

nants of international competitiveness: (1) factor conditions, (2) demand conditions, (3) related and supporting industries, and (4) firm strategy, struc- ture, and rivalry. These four determinants interact and form the “diamond” which provides the context in which a nation’s firms are born and compete.

A nation is competitive when it has specialized assets and skills necessary for competitive advantage in an industry. Firms gain competitive advantage in industries when their home base offers better ongoing information into product and process needs. They gain competitive advantage when owners, managers, and employees support intense commitment and sustained investment. In the end, nations succeed in particular industries because their dynamic home environment stimulates firms to upgrade and widen their advantages over time. Therefore, the effect of one determinant is deter- mined by the state of the others: the advantages in one determinant can enhance the advantages in others.

Porter’s theory also includes two additional variables: chance and government. Chance events are developments outside the control of firms, and they include pure inventions, breakthroughs in basic technologies, wars, external political develop- ments, and major shifts in market demand. Govern- ment at all levels, on the other hand, can improve or detract from a country’s national advantage. Regulations and investment policies can affect domestic rivalry and home demand conditions. The government variable explains why Bermuda and the Cayman Islands, while not being well endowed in terms of factors of production, capture 31.5 percent and 12 percent respectively of the world’s captive insurance operations.¹⁰

The “diamond” promotes the “clustering” of a nation’s competitive industries. The country’s successful industries are usually linked through vertical (buyer/supplier) or horizontal (common customers, technology) relationships. This cluster of industries is mutually supporting, and the derived benefits flow forward, backward, and horizontally. As in the case of Sweden, it is successful not only in pulp and paper but also in wood-handling machin-

ery, sulphur boilers, conveyor systems, pulp-making machinery, control instruments, paper-making machinery, and paper-drying machinery. Sweden is also internationally competitive in chemicals that are used in pulp and paper making.

Porter’s theory seems logical and is supported by empirical evidence. Yet one may wonder whether the broad-based generalizations are warranted. For example, it is doubtful that the theory can explain why Sweden, a relatively small country, is the third largest exporter of music. Likewise, in the case of American pastimes, one has to wonder why foreign- born Latinos are so good at playing baseball to the point that they account for 25 percent of the major league rosters, not counting thousands more from the Caribbean as well as Central and South America who play in the minors.

In fairness, Porter does offer a number of expla- nations or qualifications. A country’s national com- petitive advantage in a particular industry may be eroded when conditions in the national diamond no longer support investment and innovation to match the industry’s evolving structure. Some important reasons for the loss of advantage are: deterioration of factor conditions, local needs not compatible with global demand, loss of home buyers’ sophisti- cation, technological change, firms’ adjustment inflexibility, and reduction in domestic rivalry. In this regard, Porter has clearly stated that his theory is dynamic.Yet by advocating clustering, the theory also looks static in the sense that it implies that new- comers (nations) will have difficulties in gaining competitive advantage in a new area.

Figure 2.4 shows the world competitiveness scoreboard for nations whose populations exceed

20 million people. Figure 2.5 provides rankings for smaller countries.

A CRITICAL EVALUATION OF TRADE THEORIES

The validity of trade theories

Several studies have investigated the validity of the classical trade theories. The evidence collected by

0 10 20 30 40 50 60 70 80 90 100

0 10 20 30 40 50 60 70 80 90 100

100.00 (1) USA 1

86.547 (3) AUSTRALIA 2

84.123 (2) CANADA 3

72.872 (6) MALAYSIA 4

69.768 (4) GERMANY 5

69.283 (7) TAIWAN 6

66.489 (5) UNITED KINGDOM 7

66.407 (9) FRANCE 8

59.758 (8) SPAIN 9

58.416 (13) THAILAND 10

56.303 (11) JAPAN 11

50.813 (12) CHINA MAINLAND 12

47.787 SAO PAULO 13

47.354 ZHEJIANG 14

46.476 (10) KOREA 15

44.499 (20) COLOMBIA 16

44.310 (14) ITALY 17

43.877 (16) SOUTH AFRICA 18

42.507 MAHARASHTRA 19

42.181 (17) INDIA 20

40.667 (15) BRAZIL 21

37.851 (18) PHILIPPINES 22

33.636 ROMANIA 23

33.337 (19) MEXICO 24

29.803 (23) TURKEY 25

24.584 (21) RUSSIA 26

21.526 (22) POLAND 27

13.213 (25) INDONESIA 28

100.00 (2) FINLAND 1

98.159 (6) SINGAPORE 2

92.363 (4) DENMARK 3

90.311 (10) HONG KONG 4

89.730 (3) SWITZERLAND 5

88.683 (5) LUXEMBOURG 6

87.142 (7) SWEDEN 7

86.475 (1) NETHERLANDS 8

83.377 (11) ICELAND 9

82.579 (8) AUSTRIA 10

79.355 (9) IRELAND 11

75.761 (12) NORWAY 12

74.557 (13) BELGIUM 13

72.198 (14) NEW ZEALAND 14

67.003 ILE-DE-FRANCE 15

61.542 (15) CHILE 16

59.781 (16) ESTONIA 17

57.520 BAVARIA 18

56.060 RHONE-ALPS 19

52.243 CATALONIA 20

45.554 (19) CZECH REPUBLIC 21

43.567 (17) ISRAEL 22

42.463 (18) HUNGARY 23

41.391 LOMBARDY 24

35.174 (20) PORTUGAL 25

34.174 (21) GREECE 26

30.288 (23) SLOVAK REPUBLIC 27

12.464 (26) ARGENTINA 29

9.811 (24) VENEZUELA 30

29.170

27.768

(22) SLOVENIA 28

JORDAN 29

Figure 2.4 The world competitiveness scoreboard (larger nations), 2002 rankings are in brackets

Source: IMD World Competitiveness Yearbook 2003, 4.

Figure 2.5 The world competitiveness scoreboard (smaller nations), 2002 rankings are in brackets

Source: IMD World Competitiveness Yearbook 2003, 4.

MacDougall shortly after World War II showed that comparative cost was useful in explaining trade patterns.¹¹ Other studies using different data and time periods have yielded results similar to MacDougall’s. Thus there is support for the claim that relative labor productivities determine trade patterns.

These positive results were subsequently ques- tioned. The studies conducted by Leontief revealed that the USA actually exports labor-intensive goods and imports capital-intensive products.¹² These paradoxical findings are now called the Leontief Paradox. Thus, the findings are ambiguous, indi- cating that, in its simplest form, the Heckscher– Ohlin theory is not supported by the evidence.

In theory, the more different two countries are, the more they stand to gain by trading with each other.There is no reason why a country should want to trade with another that is a mirror image of itself. However, a look at world trade casts some doubt on the validity of classical trade theories. Developed

countries trade more among themselves than with developing countries. There is a tendency for cor- porations in developed countries to prefer to form direct-investment ties in the other more stable, developed countries while avoiding heavy invest- ment in the fast-growing developing world.

The trade pattern shown is surprising theoreti- cally, because advanced economies have similar climate and factor proportions and thus should not trade with one another since there are no compar- ative advantages. Apparently, other variables in addi- tion to factor endowment play a significant role in determining trade volume and practices because considerable trade does occur between developed nations.