Competitiveness Indicators - A Theoretical and Empirical Assessment


WP/94/29-EA
Competitiveness Indicators: A Theoretical and
Empirical Assessment by Ian W. Marsh and Stephen P. Tokarick

This paper discusses five indicators of competitiveness: real exchange
rates based on consumer price indices, export unit values in manufacturing,
normalized unit labor costs in manufacturing, the relative price of traded
to nontraded goods, and the ratio of normalized unit labor costs to value-
added deflators in manufacturing. It discusses how each of these measures
is associated with changes in a country's balance of trade in goods and
nonfactor services, changes which are relevant for an assessment of
competitiveness, and examines how each of these indicators is related to
each other. The conclusion reached in this part of the paper is that each
indicator of competitiveness possesses shortcomings, and that no one
indicator provides an unambiguous assessment of competitiveness. In fact,
reliance on competitiveness indicators should only form part of any
assessment of the appropriateness of a country's exchange rate, given the
many limitations inherent in the construction of these indicators. The
paper suggests that competitiveness indicators should be used in conjunction
with other indicators in order to obtain an assessment of competitiveness
that is as complete as possible.

Given this fact, the paper examines the empirical performance of three
of the indicators (real exchange rates based on consumer price indices,
export unit values in manufacturing, and normalized unit labor costs in
manufacturing). The empirical analysis shows that none of the indicators
works well uniformly across countries. It is impossible to unequivocally
recommend one indicator above all others to explain both import and export
flows at all levels of aggregation in every G-7 country. Because movements
in real exchange rates may be dominated by volatility in the nominal rate.
Therefore, no one indicator may be elevated to the status of the best
indicator.

From a policy point of view, the implications are clear--in examining
an issue as complex as trade competitiveness, the use of competitiveness
indicators should form only part of the analysis.