Competitiveness, Michael Porter remarked in The Competitive Advantage of Nations, his 1990 best-selling book, means different things to different people. As a member of US President Ronald Reagan’s competitiveness commission in the 1980s, the American economist met business leaders who believed it was about a global strategy to compete in world markets and members of Congress who thought it meant having a positive balance of trade. Today this commonly used term continues to defy definition and to divide opinion.
If increasing competitiveness means boosting productivity, economists would agree that this is almost always and everywhere a worthy goal. But they would also note that more productivity raises a country’s welfare regardless of its effects on exports and even if the country doesn’t trade at all with other countries.
Competitiveness, however, implies that relativity matters—that policymakers are less concerned about their country’s absolute level of productivity than about how it compares with that of other countries. If another country’s productivity is on the rise, it must be bad news, because their own country is becoming less competitive. Does this reasoning stand up?
Worrying about a competitor’s productivity makes sense in a zero-sum competition like soccer. If another soccer team in the league gets better, it means that my team has a worse chance of winning the championship. However, a key insight from economics is that world trade is not a zero-sum game. By allowing each country to specialize in the goods and services it can produce most efficiently, global trade increases productivity worldwide, and everyone is better off.
Terms of trade
So is it good or bad for my country if a foreign country increases its productivity? As is usually the case in economics, the answer is, It depends.
When a foreign country produces a certain good more efficiently, it typically raises the global supply of this good, reducing its price. If your country is mainly an exporter of this good, the lower world price for your exports will typically make your country worse off. But if your country is mainly an importer of this good, the lower world price means your country will likely be better off because it will now pay less for imports.
In other words, the effect of a foreign country’s higher productivity depends on how it affects your country’s terms of trade—the price of your country’s exports relative to the price of its imports.
For small countries (or regions) that specialize in the production of a few goods, these effects can be large. Suppose a small country specializes mainly in the production and export of a particular type of robot that becomes obsolete when foreign competitors invent a superior robot. The economic effects on the small country could be devastating.
Economists such as Paul Krugman, however, have shown that terms-of-trade effects from changes in productivity in foreign countries are typically small for large, diversified economies such as the United States, China, and the European Union. This is because large economies tend to rely less on foreign trade. Also, the trade that does occur tends to be spread across a range of products. Consequently, productivity improvements in other countries tend to affect both import and export prices, so the net effect is modest relative to the large gains from improvements in a country’s own productivity.
Moreover, it’s also typically easier for a country to affect its own productivity than that of another. This is why the focus of economic reforms in most countries should be increased productivity rather than increased competitiveness.
Export prices
A second strategy for raising a country’s competitiveness is to reduce the price of its exports, which raises export sales volume. In countries with widespread collective bargaining, this can be done by keeping wage growth in check—provided businesses use the savings to hold output prices down.
Sometimes countries try to achieve a similar effect by attempting to weaken their currency—that is, changing its exchange rate so that each unit of foreign currency buys more units of domestic currency. Exchange rate depreciation is another way countries can try to reduce export prices (and wages) when measured in foreign currency, which gives their exports a competitive advantage in foreign markets.
But if a country is already near full employment, more demand for its exports will exceed its capacity to produce them. This excess demand will push up prices and wages, and the improvement in competitiveness will vanish.
To avoid this result, the government could combine currency depreciation with measures to reduce aggregate demand, such as raising taxes or cutting spending. Currency depreciation would then increase demand for exports, while fiscal tightening would reduce demand for domestically consumed goods. Together, such policies would shift employment and production toward export sectors and away from sectors that produce for domestic consumption and investment. National income would be unchanged, but national savings would be higher because the government would run larger fiscal surpluses (or smaller deficits), and domestic consumption would be lower.