Competitiveness SL

8/13/2019 Competitiveness SL

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September 3, 2004 -- 6

6

Does Foreign Productivity GrowthErode Our Competitive PositionTwo countries: US, Taiwan

Two goods: A, B

Exchange rate: e= 1 [$/Won]

1990 Taiwan US

Output perworker

Price Output perworker

Price

Good A 1 Won 1 2 $1

Good B 1 Won 1 2 $1

Wage Won 1 $2

US has absolute advantage (higher productivity) in both goods

Competitive pricing:

Price = [Wage rate] / [Output per worker]

Both goods cost $1 in world markets

There is no international trade


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7

1998 Taiwan US

Output perworker


Price

Good A 1.1 Won 0.9 2 $1

Good B 1.2 Won 0.8 2 $1

Wage Won 1 $2

10-20% productivity growth in Taiwan, but not in US

At e= 1: U.S. is not competitive in either market

Excess demand for Won $ depreciates

What is the new exchange rate?

Dollar depreciates until U.S. becomes competitive in good A

9.0/$1.11$

*

WonWon

pep AA

=

=

Key point: Countries are automatically competitive,

if exchange rates are flexible.


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8

Pattern of Trade

At the new exchange rate, the dollar price of good Bis:

9.08.01.1* =Bpe

U.S. cannot compete in good B

Pattern of trade:

Taiwan produces all Band exports some to USTaiwan may also produce some A

US produces only Aand exports some to Taiwan

Key insight from trade theory:

The pattern of trade depends on comparative advantage, not on

absolute advantage.

The U.S. has a comparative advantagein A, because itsproductivity advantage for Ais greater than that for B:

BgoodintyproductiviForeign

AgoodintyproductiviForeign

BgoodintyproductiviSU

AgoodintyproductiviSU>

..

..

Here: 2.1

1.1

2

2>


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9

Who Gains From Taiwanese Productivity Growth?

US nominal wages have not changed (still $1)But US real wages have risenbecause the price of good Bhas dropped from $1 to $0.9

Foreign productivity growth has cost jobs in sector B, but an equalnumber of jobs were gained in A

Key insight:

Trade with low wage countries neither creates nor destroys jobs


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September 3, 2004 -- 10

10

What if Taiwan Pegs Against the Dollar?

Now Taiwan offers goods in world markets for:90.0$9.01* ==Ape 80.0$8.01

*==Bpe

The US must lower wages to compete:

1998 Taiwan US

Output perworker


Price

Good A 1.1 Won 0.90 2 $0.90

Good B 1.2 Won 0.80 2 $0.90

Wage Won 1 $1.80

The trade pattern and real wages are the same as under flexibleexchange rates.

Key insight: Flexible wages ensure that a country remains

competitive, even if the exchange rate is fixed


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September 3, 2004 -- 11

11

Lessons from the Example

1. Low wages do not provide a competitive edge.Domestic wages reflect domestic labor productivity.

U.S. wages are not set in Beijing

2. We benefit from foreign productivity growth through lower pricesfor imported goods.

There is no loss of jobs or output.

3. The exchange rate takes care of productivity differences

4. Therefore: Countries are always competitive.

Competitiveness is only a problem, if a country fixes the exchange

rate andnominal wages.


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September 3, 2004 -- 12

12

Why the Opposition to Free TradeLoss of high value added jobs

Our standard of living can only rise if capital and laborincreasingly flow to industries with high value-added perworker. -- Magaziner and Reich

But: It is traditional industries (oil, steel) that have the highestvalue-added per worker (not high tech industries; why not?)

Trade leads to redistribution of income

There are losses of employment and capital income in importcompeting sectors

E.g.: Protecting the local farmer. Voluntary import restrictionsin the car industry. Nafta.

What about dumping?

Trade policy as a lever for human rights or environmental concerns

E.g.: WTO/Seattle. MFN for China.

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Competitiveness SL