Politicians Strive for Competitiveness

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Title and author: "Politicians Strive for Competitiveness" — KEVIN FLETCHER.
Publication date: June 2025.
Central thesis: While "competitiveness" is a commonly used but ambiguous term, boosting productivity is "almost always and everywhere a worthy goal" and is generally the better path to prosperity than focusing on relative competitiveness with other countries.
Key conceptual distinction: Competitiveness implies relativity—how a country’s productivity or prices compare with other countries—whereas productivity improvements raise welfare regardless of trade.

Core insight: The effect of another country’s productivity increase "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.
Scenarios:
- If your country is mainly an exporter of a good whose global supply and price decline due to foreign productivity gains, your country may be worse off.
- If your country is mainly an importer of that good, lower world prices likely make your country better off.
Special cases:
- Small, specialized countries can suffer large negative effects (example: a small country specialized in a particular robot that becomes obsolete).
- Large, diversified economies (United States, China, and the European Union) typically face only modest terms-of-trade effects from foreign productivity changes because they rely less on foreign trade and trade is spread across many products.
Policy implication: It is typically easier and preferable for countries to raise their own productivity than to try to influence other countries’ productivity.

Mechanisms to boost export competitiveness:
- Keep wage growth in check (where collective bargaining is widespread) if businesses use savings to lower output prices.
- Exchange rate depreciation: weaken the currency so each unit of foreign currency buys more units of domestic currency, reducing export prices in foreign-currency terms.
Capacity constraint caveat:
- If a country is near full employment, higher export demand will exceed capacity, pushing up prices and wages and erasing competitive gains.
Combined policy option:
- Pair currency depreciation with measures to reduce aggregate demand (for example, raising taxes or cutting spending) so depreciation increases export demand while fiscal tightening reduces domestic demand.
- Accounting outcome: National income unchanged; national savings higher because government runs larger fiscal surpluses (or smaller deficits); domestic consumption lower. Employment and production shift toward export sectors.

Accounting identity: A country’s trade balance (exports minus imports) equals the difference between its savings and investment.
Implications:
- To raise the trade balance policymakers must raise national savings or reduce national investment.
- Whether this is desirable depends on whether savings and investment are at appropriate levels or distorted by policy failures.
Legitimate competitiveness concerns:
- Example: Lax financial oversight → influx of foreign capital → unsustainable credit-fueled boom in consumption and speculative investment → higher wages and prices → large trade deficit that may presage a damaging bust.
Too much competitiveness:
- High national savings or low investment can make a country "too competitive" (example: underinvestment in public infrastructure).
- Increasing public investment (and fiscal deficits) could boost productive capacity, raise domestic wages and prices, and reduce export competitiveness as part of a beneficial reallocation toward domestic investment when returns to domestic investment exceed those in export sectors.

Common metric: trends in share of world exports.
- Limitation 1: Ignores the import side; value added in exports may be much lower because components are imported. Alternative: look at trade balance (exports net of imports).
- Limitation 2: Export share can fall because an economy declines as a share of the world economy for reasons unrelated to competitiveness (for example, slow population growth). Alternative: trade balance as a percentage of GDP.
- Limitation 3: Trade balance as a share of GDP is affected by the business cycle. Adjustment: "cyclically adjusted trade balance" that adjusts trade balance and GDP to neutral-phase estimates.
- Limitation 4: Trade balance reflects savings-investment balance; there may be valid reasons for large surpluses or deficits (for example, high saving to prepare for future population aging; poor countries needing foreign investment to grow).
IMF approach:
- Adjust the cyclically adjusted trade balance for factors that justify large surpluses or deficits and focus on the residual—imbalances attributable to policy distortions or unexplained factors. This is the approach taken by the IMF’s External Balance Assessment.
- Complementary metric: real effective exchange rate (REER) — the evolution of a country’s price level measured in the trade-weighted average currency of trading partners. A substantial rise in the REER or a high REER for a country’s level of income "may also indicate a lack of export price competitiveness."

Main conclusion: Boosting economy-wide productivity is often a more appropriate policy goal than pursuing relative competitiveness.
When competitiveness focus is warranted:
- Concern over price-level competitiveness can matter when it leads to trade imbalances linked to policy distortions (for example, unsustainable credit booms).
- These problematic situations are "less common than most policymakers realize" and are "difficult to identify" even with standard indicators.
Practical guidance:
- Prioritize policies that raise productivity domestically.
- Use targeted diagnostics (cyclically adjusted trade balance, adjustments for justified surpluses/deficits, REER) to identify genuine competitiveness problems before pursuing policies aimed at altering trade balances.

KEVIN FLETCHER, assistant director in the IMF’s European Department; "Politicians Strive for Competitiveness," June 2025.

Politicians Strive for Competitiveness
- Politicians Strive for Competitiveness (Markdown version)
- Politicians Strive for Competitiveness (PDF)