Number 2. Competing nationally doesn't teach a thing to a kid if he doesn't get a chance to play. Sure he gets a uniform and he can brag that he is on 'THE TEAM' but ultimately his baseball skills will not improve. He will stagnate and I suspect he will not have much fun just sitting there.
If he plays for team 2 he will have much more practice, much more interaction on the field and off the field with his teammates, much more experience actually playing the game. Coaches that have played at the Collegeate level are very good, better than most coaches and he should be able to learn a lot.
This one is a no brainer to me and I am a father of a 12 year old.
One more thing: Ask your son. What does he want to do? Last year my son played on a team that was frankly below his talent level because he wanted to be there to both play with his friends and hopefully help them win more games than they normally would. I went along with it although I personally thought a top tier team would have been a better fit for him. This year he decided that travel ball is what he wants to do so we are going that route.
Get his input, and don't try to force him to make one decision or the other. Let him know your opinions and make sure he himself voices the pros and cons to both but get his unfiltered opinion.