Political Economics Of National Competitive Strategy

Traditionally, international economics has been split two sections: international trade theory—which focuses on the pattern of trade and gains from trade etc, the micro economics in international arena, and international finance theory----which focuses on international monetary system and exchange rate regime etc, the macro economics in international arena. The gap obviously exists which implies it is necessary to find the linkage to shrink the gap and international economists have strived substantial convergence in the past decades. Unfortunately, it seems no one has made the distinct progress yet. Overcoming the split require changes not only on both sides, but also methodologies. It is crucial to develop a new framework which can accommodate both areas of international economics as well as new philosophy on methodologies.It is helpful to trace back the main stream of traditional trade theory when new framework is expected to built. Ricardo's comparative advantage theory has been regarded as a cornerstone of traditional classical and neoclassical international trade theories in the past two centuries, which states that international trade can benefit all nations simultaneously because specialization allows total global production volume to increase, due to the efficient allocation of resources.Apparently, Ricardo's theory highlights that comparative advantage arises from difference of productivity. Heckscher and Ohlin took a large step further by exploring what happened if two nations have the same production function, e.g. comparative advantage no longer comes from different productivity; it arises from difference in national factor endowments. Thus, the H-O factor proportions theory derives the determinants of comparative advantage in a world of'two-ness'(two goods, two factors, two countries) and the assumption of perfect competition. The goal of H-O theory is to analyze mobility in the sense of flows of goods and immobility of factors makes sure the existence of differences of factors'prices The New Trade Theory stresses product differentiation and increasing returns to the list of determinants of trade patterns, they are not adequate either. Because it emphasis the similarities, rather than difference on the explanation of determinants of trade patterns, and it relies almost completely on monopolistic competition to explain intra-industry trade, which may lead to develop the"two-ness"trade model, and the national conflicting interests can be emerged arising from retainable industry and multi-equilibriums due to increasing returns and externality.Retainable industry is regarded as a one source of multi-equilibrium in international trade. Retainable industry refers to an industry with highly starting-up cost and it is difficult to entry without large scale, expertise, skills and experiences. Retainable industry shows lock-in effect of the country's comparative advantages, which suggests the industry sustaining competitiveness, coming from know-how, expertise on the market, experience, learning by doing technique etc.Another extremely case of retainable industry occurs in the industry with very short product life cycle. The advanced countries can keep their first mover advantages in such so call retainable industry even though their trade partners'wealthy has improved by offering intermediate products to advanced countries.The trend of globalization in the past decades brings about revolutionary change in global production. Outsourcing, supply chain management, and other sort of new style of production increase the volume of international trade and change production pattern and trade pattern dramatically. Global value chain shows each country position in the process of value chain creation, which determines the pattern of international trade.In other words, current pattern of trade may lead to the situation that the retainable industry in developed countries has state-of–art technology, whereas the retainable industry in developing countries has technology exported from developed countries.This could be a long process until its trade partners'exports reach some point in global market by increasing marketing share, which implies developing countries becomes disadvantages of developed countries, or in shortly, some industries in developing countries have strong competitiveness in global market, or low cost exports from developing countries induce deflation in advanced countries, then mutual-beneficial trade for trade partner has involved to the conflicting interests of nation. Two types of economic growth patterns have co-existed and advanced countries'endogenous growth pattern represents the core economy's pattern and the developing countries represent the non-core economy pattern respectively, and the pattern has changed global trade pattern profoundly.Obviously, traditional neo-classical international trade theory, either Ricardo comparative advantage theory, or H-O factor endowment model, cannot draw a picture closely related to real world reality. Three reasons may be provided to explain the drawbacks of comparative advantage. First, comparative advantage is a microeconomic concept, which emphases on industry-specific trade, and it has little significance from macroeconomic perspective. Second, comparative advantage is an equilibrium concept and it cannot describe multi-equilibrium which reflects business decisions, favorable exchange rate and other economic conditions. Third it does not take explicitly into account the technological options available to firms. It is necessary for further research to develop a new concept in international trade theory. Competitiveness, a widely used term in business administration literature, and closely related concept, competitive advantage has been embedded in literature by Porter.The Competitive Advantage of Nations focus on industry level and it is formed as a diamond by factor endowments, domestic demand condition, supported and related industry, strategy, and structure as well as rivalry competition. Moreover, government policy and chance are also very important for attaining successful competitive advantages.Unfortunately, some economists have either ignored the concept of competitive advantage, or dismissed it as merely a restatement of comparative advantage. Porter's approach to explore competitive advantage is not a traditional economic methodology. It is case-study approach, which is popular on business administration, highlighting on the way which factor productivity and firm competition interact. The simplicity of the case-study approach shows less rigorous, comparing with traditional strict demonstration process. So it is necessary to develop a theoretical framework which can encompass neo-classical methodology with the new concept of international competitiveness or competitive advantage by Porter's term.International competitiveness typically refers to a time of disequilibrium when a country can increase its share of export markets. It is a matter first of low costs, which depend on exchange rate, domestic wages and material costs and productivity, transportation and communication costs, trade barriers and trade strategy. It is a dynamic rather than static perspective. The concept combines both on macro and micro level. To some extent, international competitiveness is meant the ability of a country's producer to command world markets; thereby it is highly related to competitive advantages,What exactly is competitive advantage? And how does it relate to and interact with comparative advantage? One possible answer is that it is something to do with more competitive markets: simply a large number of firms may give an industry advantage in competing with foreign rivals. Another possible answer is that competitive advantage is just a synonym for absolute advantage: some natural or policy-induced superiority (such as lower taxes or greater labor market flexibility) which reduces costs for all home sectors.Therefore, a country gains competitive advantage may reflect underlying factors and productivity consideration, which closely related to current exchange rate, undervaluation or overvaluation, product quality and specifications, tariffs and NTBs, as well as transaction costs of trade. This paper focus on how a favorable exchange rate increases a country competitive advantage.Globalization, the most controversial and wildly recognized concept, has changed the world profoundly. To some extent, globalization spreads technology, weakens power of authoritarian governments, provides exposure to other cultures, etc. Furthermore, globalization offer consumers more choices and multinational corporations are creating jobs in less developed countries where people never before had such opportunities.In international arena, globalization has increased both trade liberalization and financial deregulation, which both reward to the tremendous volumes of international trade and more mobility of international capital as well as the opening international markets between OECD members and emerging economies. Moreover, the financial deregulation impulses have positive effect on trade account. Diminishing non-traffic trade barriers and declined traffic are the fruits of trade liberalization; With non-trade barriers (NTBs) removed and tariff reduced, nations have recognized the limitation of employing tariff to protect domestic industries, and they have to seek other policy instruments as useful means of government interventions. It may leads to trade policy reform, which could meet the needs of trade liberalization to improve the efficiency by creating a transparent and neutral system of incentives that eliminate anti-export bias, direct impediments to trade, and economic distortions caused by the trade regime. Although only some countries undertook such program managed to reduce to some extent the degree of trade policy distortions in good practicing, most trade literature highlights the positive externalities derived from more competition in trade relations. Furthermore, free international trade contributes to national prosperity, which may increase national power and enhance security. On the other hand, it has the same effect on a nation's trade partners, which could become a political or even military rival. The resulting ambivalent attitude is torn between the vision of state cooperating for economic gain and recognition that they also use trade to compete for political power.Nations try to pursuing effective policy instruments to increase its export and gains from trade, meanwhile they also quest effective way to prevent trade that could be more beneficial to its trade partner. The perception reflects macroeconomic policies and nation's distinct response to the interdependence in regional/ global integration.Trade and macroeconomic policies (monetary policy, fiscal policy) are well known policy instruments for government, the linkage and the mutual functions between trade and macroeconomic policies, however, is less well known. A well designed and sequenced trade liberalization measure and delectated arranged trade rules can facilitate economic growth and development. But the extent of that contribution heavily depends on other policies.So far, an international trade model has been extent to more complicate case this involves not only a barter trade, but also currency side, and the importance of exchange rate policy-making has been recognized by government, as a result, exchange rate fluctuation becomes a tool to deal with trade disputing.In the past decades, especially after the breakdown of Breton Wood system, floating exchange rate system is implemented in most developed countries and this brings about to a large number of literatures focus on the relation of exchange rate movements and stability of trade policy, employment, productivity, income distribution, nation's external wealth, economic growths, etc. In an open economy, macroeconomic equilibrium has twofold balances: the first one is internal balance, which refers to output at full or near full employment, and related to domestic goods, financial and labor markets; and the second is external balance, which refers to terms of a sustainable current account balance and it's financing. Therefore, the level of current account imbalance directly reflects the difference between national income and spending. Current account deficits can be made up by capital inflow, or by foreign reserves, etc. A nation with positive net external asset position enables it to run persistent trade deficits. In turn, all else equal, the capability to sustain a negative net export balance in equilibrium is associated with an appreciated real exchange rate. Conversely, a debtor nation which has to run trade surplus to reimburse its external liabilities can pursuit a more depreciated real exchange rate. Furthermore, the size of trade surplus, which a debtor country needs to refund its external liabilities, will depend on the rate of return it has to pay on these liabilities, as well as on its output growth rate, and exchange rate. And the real exchange rate. Thereby, most previous works focus on the exchange rate volatility and trade balance or export; others stress the real exchange rate play critical role in altering international competitiveness, which is fundamental factor of determining nation's reorientation toward its trade partners.As mentioned in the previous part, macroeconomic policies, such fiscal policies, monetary policies as well as exchange policies have been applied to attain the goal for one nation's best interest. But a unified exchange rate system provides protection effect on firms profoundly different as firms operate with distinct cost of product; on the other hand, unified exchange rate system does not discriminate between domestic and foreign firms while traffic does. Therefore, firm which receive insufficient protection under the circumstance increase pressure for government protection by other policy instrument rather than existing exchange rate?Therefore, a country gains competitive advantage may reflect underlying factors and productivity consideration, which closely related to current exchange rate, undervaluation or overvaluation, product quality and specifications, tariffs and NTBs, as well as transaction costs of trade. This paper focus on how a favorable exchange rate increases a country competitive advantage.This dissertation focuses on the exchange rate and a nation's competitive strategy which can accomplish national international competitiveness, and exchange rate is regarded as an instrument of national competitive strategy, which refers to a set of integrated and coordinated actions taken to enhance a nation's competitive advantages. A unified exchange rate system has distinct effect on individual firms in a country, some may gain beneficial, and some could be damaged. Those groups, who do not gain from exchange rate may use its power to influence government policies; one the other hand, when government set it exchange parity it has to take several factors in consideration, export structure, its policy coherence and international cooperation, which may assist government to attain their objectives and gain economic efficiency and international competitiveness from international cooperation, especially in global economic integration.It is well known there are so many indicators on exchange rate, such as equilibrium exchange rate, nominal exchange rate, real exchange rate and effective exchange rate, and their combinations, with respect exchange rate determination theories. With distinct definitions, economists choose different concept depending on their field and the content related to economic implications. For instance, nominal exchange rate is a proper indicator to study a high-frequency volatility exchange market which can show the dynamic change in international financial market when it is necessary to supervise capital movement, financial globalization; effective exchange rate is a useful tool to study a nation's ability to command the rest of world in world market due to its reflecting a nation's export/import weight change; and real exchange rate is popular to study PPP or Balassa-Samuelson effect when a country's economic development is considered; and equilibrium exchange rate is more meaningful as a benchmark in theoretical study when a country's economy internal and external equilibrium are taken into consideration.A country's economic development demonstrates its international competitiveness, it is reasonable to focus on the relationship between real exchange rate and economic development, which have been studied both from the positive (descriptive) and normative (policy prescription) perspective. Whether real exchange rate stability and proper exchange rate alignment are crucial factors to increase international competitiveness and improve economic performance? Can government manipulate exchange rate to achieve its economic prosperity? Even though evidence from developing countries is often quoted to support the view the link between the real exchange rate misalignment and economic performance is strong. Therefore, successful economic development generates a domestic currency appreciation with an improvement in the standard of living, whereas a failure in economic development results in sharp currency depreciation. It is important to assess the degree of misalignment as one evaluates the equilibrium real exchange rate, and one of the most important models on equilibrium real exchange analysis is well-known Balassa-Samuelson effect. Balassa-Samuelson effect states the real exchange rate level is positively correlated with development degree of the economy because of differential productivity growth between tradable and non-tradable commodities. The Balassa-Samuelson model provides a supply-side explanation for the relative price of tradable and non-tradable in an economy and assuming that PPP holds for traded goods, both for the differences in price levels of development and long-run behavior of CPI-deflated real exchange rate. To establish that the relative price of tradable and non-tradable, and thus the price level composed of tradable and non-tradable goods prices, is determined entirely by supply conditions, i.e. the production functions of an economy, several assumptions are neededIn other words, real exchange rate appreciation is associated with a country's economic development. It is inevitable that domestic currency appreciates as its rapid economic growth. Previous research indicates favorable exchange rate is one of sources of competitiveness. What could be the strategic choice if a country is facing an inevitable exchange rate appreciation after its fast growth? Several strategies would be taken into consideration: stability (keeping the exchange rate unchanged), appreciation or depreciation, overvalued or undervalued, and any options can reflect the best interests of home country.Hence, one feasible direction of research could be how a country manipulates its real exchange rate through the exchange rate misalignment as an effective mean to achieve its best interests among the nation's interest conflict in international trade. This misalign exchange rate is defined as'strategic exchange rate'referring its implication of government instrument perusing its strategic goal. Thus the strategic exchange rate is disequilibrium and non-linear, and government try to employ the misalignment to attain it strategic goal----perusing the best interests of the nation in the second-best circumstance.Tinbergen's Rule suggests that one instrument can only attain one macroeconomic goal. Mundell pointed out government and central bank can use fiscal policy and monetary policy for external balance and internal balance respectively. With free capital mobile, monetary policy can reach an external goal (e.g. exchange rate stability), or internal (domestic) goal (e.g. inflation rate). It is impossible for monetary policy to reach the external as well as internal goals simultaneously, and the statement has been referred as the famous"incompatible trinity", which is on the basis of free capital mobility and fixed exchange rate regime (regarded as external balance goal). If, on the hand, the assumptions are shifted to uncompleted capital mobility, the"compatible trinity"can be established and exchange rate can be viewed as a instrument to accomplish external goal (especially in monetary zone which each member has to scarify its independent monetary policy). Even though the exchange rate has dual functions---policy goal and policy instrument, it is an effective tool for government implementing its national competitive strategy.How can the government determine the strategic exchange rate? By employing New Political Economics method, this dissertation demonstrates two forces can determine the value of strategic exchange rate----one is the domestic interest groups and the other is foreign trade partners'pressures.Interest group represents people pursuing the same or similar goal and interests establish groups, organizations etc, and try to attain favorable policy by lobbying. Different interest groups act as distinct benefits and each of them do its best to maximize its interests leading to conflicting among groups. Government decision-makers are lobbied by different interest groups in order to reward a favorable policy and more wealth of the groups.In the last part of this dissertation, China's experience is presented as a case of national competitive strategy evolutionary process.After 15 year-long quest, China became the 143rd member of WTO on 11 December 2001. WTO accession means for China a curial step forward in its unprecedented strategy to catch up with the advanced industrial world by means of market socialism. The future of China's modernization is dependent on the reactions of the rest of the world to China's economic growth. Since committed to WTO, China has reduced a large portion of its import tax in the past years, but are still suffed some unexpected trouble—antidumping allegation, which is mainly an excuse to force China appreciating its currency. Thus, one lively and concentrated research area in international economics has accompanied the process of appreciating Chinese currency, Renminbi (RMB). Is this process appropriate and reflects the relality of China economy ascending? If the answers for these questions are positive then the adjustment process of RMB indicates the trend of PPP, which is reasonable and implying the equilibrium may be reached in the future, so there is no necessary to use government policy interventions. If the appreciation of RMB suggests the pressures aroused from China trade counterparts, especially from USA, which indicates the adjustment process may not solve the misalignment of exchange rate, and even may enhance the misalignment because of the international competitive strategic decisions by Chinese trade counterparts, which may improve their national competitiveness in world market. The appreciating process of RMB, probably, implies both causes discussed above. Under the circumstance, exchange rate plays a prominent role as an instrument for countries to winning in international competition.From inception, undervalue domestic currency is regarded as an effective instrument to increase exports by China's government and some business. This may leads to expand foreign exchange reserves by trade surplus, which is considered as beneficial for a country safeguard, especially for Chinese government, who witness the financial crises in Southeast Asia in 1998 and deem such disaster as their big concern because the Asian financial crisis reveal the weakness in the Asian development model which China had been partly pursuing. Furthermore, unlike economic reforms implemented in Europe, East Europe or Latin American, China's strategy has been unique. It borrowed from its high—growth Asian neighbors for its development, it, however, had no grand design and it is not easy to categorized its policies neatly into standard development framework. This may lead to difficulties for China to evaluate the consequence of its exchange rate system reform due to the unique pattern of economic transformation. By the same token, China has been persisting to peg its currency RMB to US Dollars, which was depreciated since the 911 terrorism attack America, as a result, increasing trade disputes arise. As matter of fact, depreciation domestic currency has twofold effects, a country can gain trade surplus by depreciation which decreases its export price and enhances international competitiveness, and this is only the part of story, depreciation may also incur the retaliation of its trade partners due nation's mutual interdependent relationship in globalization. From my perception, a country's foreign exchange price is related to it export structure. For most developing countries, such as China, the majority of its exports are good and undervaluation may be favorable, and there is a different picture in developed countries, which has been discussed in the previous part of this paper.Since the unified exchange rate system in 1994, there is little improvement on the foreign exchange rate system reform in China because the negative effect on adverse exchange rate movement has been a big concern for the government. It is seem to be the best option for Chinese government to peg China's domestic currency, Renmingbi (RMB) to US Dollars. China indeed, has promoted its exports dramatically and gain significant trade surplus due to the US Dollars depression, the successful implementing export orientated strategy as well as catching up strategy, and China's accessing to WTO, which has induced tariffs reduction of China's trade partners. Apparently, the exchange rate has become a useful instrument to promote China's exports, which could be regarded as a good example of policy coherence.However, undervalued RMB has been expected to appreciate in the past three years, and such expectation has allured net foreign assets unexpected increasing in China and lead to significant surplus of capital account. As a result, accumulation of China's foreign exchange reserves has enlarged sharply and high expectation of RMB appreciation is arising. Thus, Chinese government has to face dilemmas that involve multiple consequence of RMB appreciation, and multiple values that compete for dominance in shaping its behaviors. In order to alleviate the trade disputes arising from undervalued REM allegation, China government launched a reform plan on REM exchange rate formation mechanism on July 25, 2005, and the exchange rate of REM has been appreciated more that 20% totally in the past three and half years.Meanwhile, the negative effect on REM appreciation has emerged gradually, with declining exports, increasing unemployment, slowing down the pace of rapid economic growth, and undermining China's international competitiveness; Reforming on REM exchange rate formation mechanism, however, may also support China to gain more opportunity for international cooperation because RMB's appreciation meet the needs of China's trade partners and it is welcomed in international society.Technically, China can combine trade policy, exchange rate policy as well as other macroeconomic policy to achieve police coherence as effective tools to gain more benefits from exports promoting. Furthermore, as a member of international society, it is necessary for China to take other factors into considerations when it makes decisions, and international cooperation from trade partners play curial role for China's promoting exports. For Chinese government, it is not easy to utilize foreign exchange rate policy to enhance its international competitiveness, which heavily depends on prosperous national competitive strategy. It is a long journey for China to be a country with strong power to dominate the international financial system.Four parts are presented in the dissertation. Part one is introduction, which covers background of research, methodology, research map and framework of the research, literature review, etc. The second part is the theoretical system, which contends two sections: section one is theoretical evolution, from Chapter 1 to Chapter 4; and section two is theoretical development, from Chapter 5 to Chapter 9. Part three is factual system, which shows the evolutionary process of China's national competitive strategy, and the last part is conclusion. There is a mapping between theoretical system and factual system, and the two systems mirror each other, reflecting mutually.A research preference is indicated directly in Chapter 1. Political economic analysis rather than neo-classical welfare economic analysis is applied in the dissertation because it focuses on how political factors impact on economic choices as well as its consequences, and the optimal research object is nation's behaviors.Chapter 2 demonstrates inductive comments on evolutionary international trade theory, which attempts to find out theoretical breakthrough. Several assumptions of international trade theory have been changed in Chapter 3, and it may induce retainable industry, multi-equilibriums and national interests conflicting. Moreover, trade conflict between America and Japan as a case suggests causes, forms and nature of trade conflict. Three important concepts, international competitiveness, comparative advantage and competitive advantage, are compared after reviewing Porter's competitive strategy theory in Chapter 4 and the four chapters comprise the second part of dissertation which indicates theoretical evolution.Theoretical development is displayed in the following five chapters which are regarded as a main body of the dissertation. Chapter 5 states the mobility, production paradigm and trade pattern have been transformed in globalization due to trade liberalization and the two parallel economic growth pattern----endogenous economic growth for core economy and exogenous economic growth for non-core economy, under the circumstances, national competitive strategy become a necessary options for each countries involving international trade. Factor endowments model is developed in Chapter 6, which focuses on the expension from visible factor endowments to invisible factor endowments, thus national competitive strategy regarded as invisible factor endowment is embedded into H—O factor endowments model which suggests the innovative extension on international trade framework. Furthermore, conflicting between American and Japanese exchange rate systems provides a sufficient supporting evidence to test the invisible factor endowments model and conclusion is favorable. Nature of exchange rate is discussed in Chapter 7. Exchange rate demonstrates its neutrality as a government policy object in traditional analysis, whereas it indicates non- neutrality as a government policy instrument. The theorem of"incompatible trinity"can be established with perfect capital mobility, and"compatible trinity"can be established with imperfect capital mobility. Thus, the fundamental condition of implementing nation's competitive strategy is"incompatible trinity"with imperfect capital mobility. Strategic exchange rate is a key issue studied in Chapter 8, which is viewed as a government policy instrument to pursuing international competitiveness. A political economic model has been built to describe how the strategic exchange rate can be determined. In shortly, strategic exchange rate is mutual consequences depending on the bargaining power of domestic interest groups and the bargaining power of home country government as well as its trade partners'governments. National competitive strategy is also an effective mean to cope with business cycle discussed in Chapter 9. Strong domestic currency can be employed as a national competitive strategy to enhance its international competitiveness by core economy in economic booming; while weak domestic currency in bust. Meanwhile, exchange rate is optimal tool for risk management when the financial systemic risk emerges.As a case study, China national competitive strategy formulation process is explored in the last three chapters consisting with the factual system of Part Four, regarded as a mirro...