What is meant by competitiveness and how can governments influence a country’s competitive standing?

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Allan Hodge, Cheltenham Ladies’ College.

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When we consider a country’s competitiveness we are usually thinking of its economic performance in relation to the outside world.

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To be competitive we are saying that some aspects of a country’s structure or behaviour are enabling it to gain an economic advantage over other countries.

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The main record of economic transactions between countries is the balance of payments, so this tends to be the main focus into competitiveness.

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What iscompetitiveness 1?

At its narrowest, national competitiveness might refer to a country’s success in selling its goods and services to other countries (exports) and buying from its own firms rather than from abroad (imports).

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Trade competitiveness may lead to wider advantages such as being able to attract growth-enhancing foreign direct investment (FDI).

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An expanding surplus on trade is also reflationary as it boosts aggregate demand (AD).

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This is because net exports (X – M) are part of AD, and through export creation (the injection X rises) or the substitution of domestic production for imports (the leakage M) falls.

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This creates jobs and incomes for those directly involved and, through multiplier effects, the wider community.

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Thus being competitive may be linked to higher growth and living standards.

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With respect to trade, greater competitiveness must derive from both price and non-price factors that make a country’s goods and services more attractive to buyers, whether at home or abroad.

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What iscompetitiveness 2?

There are 3 main ways a country can increase price competitiveness of its own goods and services which are: higher productivity; a lower foreign exchange rate; and subsidies on production.

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Firstly, increasing productivity and productive efficiency is the only route having long-term beneficial effects.

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If a country is more productively efficient it can produce at lower average cost per unit.

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Price competitiveness 1

A country with consistently higher productivity will tend to have lower relative inflation.

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As a result it is better placed to sell its goods abroad and reduce its imports.

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Productivity also goes hand in hand with innovation and quality improvements, so boosting non-price competitiveness.

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The second factor is a lower exchange rate which lowers export prices in the foreign currency, and raises import prices in the domestic currency, thus stimulating export volumes and reducing import volumes.

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But it may be difficult or impossible for a country to lower the value of its currency especially with a floating exchange rate determined by market forces.

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A lower exchange rate is also no guarantee of a rise in the value of net exports unless the sum of the price elasticities of demand for X and M is greater than 1 (the Marshall-Lerner condition).

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And, this may only happen after a time lag during which net exports may actually fall as exporters and importers take time to respond to the new prices (the J-Curve effect).

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Even if the elasticities are appropriate, a country needs to pay attention to its productivity and relative inflation rates, otherwise export competitiveness will again be reduced.

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Price competitiveness 2

But, a lower exchange rate, by raising import prices, contributes to a rise in cost inflationary pressures.

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Higher domestic costs and inflation will feed through into higher export prices in the future making imports seem more attractive, and undoing the effects of the falling exchange rate.

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More fundamentally, a falling exchange rate reduces the terms of trade.

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If export prices fall and import prices rise, a greater volume of exports has to be given up to cover the purchase of a given volume of imports.

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Increased ‘competitiveness’ may be won at the increased real cost of having to give up a greater volume of goods as exports in order to get the same volume of goods as imports.

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If the aim of higher competitiveness is national prosperity and higher living standards, it must be asked whether this is a price worth paying.

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Price competitiveness 3

Giving subsidies to firms and putting tariffs on imports is the least desirable way of increasing price competitiveness as it distorts markets and leads to resource mis-allocation.

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Firms may lose the incentive to become more efficient if they are getting painless assistance from the government.

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Markets are distorted because of the production of subsidised goods is boosted artificially, without any basis in improvements in techniques or factor costs.

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Tariffs (import taxes) increase the competitiveness of domestic goods by making imports more expensive.

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But, as with subsidies markets are distorted and as with a falling exchange rate, higher import prices are inflationary and reduce consumer surplus.

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Tariffs reduce welfare, at home and abroad, and may invite retaliation.

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Price competitiveness 4

This refers to those features of products that make them attractive to buyers, other than price.

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For example, quality, innovation, reliability, product range, together with guarantees, sales service and backup.

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High non-price competitiveness may compensate for low price competitiveness, i.e. quality goods will sell even at high prices.

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Non-pricecompetitiveness

But high price competitiveness is no guarantee that poor products will sell.

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The pursuit of product improvement certainly represents a worthwhile goal which will benefit both the makers and the users of the goods and services represented.

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The world Economic Forum has developed a list of the “12 Pillars of Competitiveness” and a Global Competitiveness Index (CGI).

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In these, different factors are important at different stages of a country’s economic development.

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Firstly, factor-driven economies “compete based on their factor endowments – primarily unskilled labour and natural resources ...”

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Competitiveness –a broader perspective 1

Secondly, efficiency-driven economies “must begin to develop more efficient production processes and increase product quality ... driven by higher education and training, efficient goods markets, well functioning labour markets, developed financial markets ... and a large domestic or foreign market.”

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Thirdly, in innovation-driven economies “companies must compete by producing new and different goods using the most sophisticated production processes and by innovating new ones.”

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The UK is classified as one of the “innovation-driven” economies.• C

Our strengths are a flexible and efficient labour market, with ‘sophisticated and innovative businesses that are highly adept at harnessing the latest technologies for productivity improvements and operating in a very large market.’

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However, the country’s macroeconomic environment represents the greatest drag on its competitiveness, with a fiscal deficit above 8% in 2012, amounting to 90.3% of GDP.

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We also have a comparative low national savings rate at 10.8% of GDP.

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However, in 2013 the UK ranked 10th overall in the CGI out of 148 countries surveyed.

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Competitiveness –a broader perspective 2