14.14 - International Competitiveness
The meaning of international competitiveness and price factors
International competitiveness refers to a country's ability to produce goods and services that offer better value than those from rival nations, encouraging buyers to choose them based on factors like price and quality.
Price factors used to measure competitiveness
Relative unit labour costs:
- These measure the labour expenses required to produce a unit of output.
- Lower costs compared to other countries enhance competitiveness by allowing cheaper production and sales.
- Comparisons often convert costs to a common currency and use index numbers to account for national differences, ensuring fair evaluations.
Relative productivity:
- This indicates output per worker or per hour.
- Higher productivity boosts competitiveness by reducing costs per unit, similar to lowering labour costs.
Relative export prices:
- Influenced by exchange rates and labour costs, especially in labour-heavy sectors like manufacturing.
- A currency depreciation makes exports cheaper abroad, improving competitiveness.
- Capital-intensive industries rely less on labour costs for pricing.
The term 'relative' means these factors are compared against competing countries.
Non-price factors influencing competitiveness
Beyond pricing, non-price elements play a key role in determining how attractive a country's products are to global buyers. These can be enhanced through effective management and technological investments.
Key non-price factors
- Design - Products that align with consumer preferences and trends are more likely to attract buyers.
- Quality - Well-constructed items that perform as expected build trust and repeat business.
- Reliability - Goods that function consistently over time reduce buyer hesitation.
- Availability - Easy access to products, through efficient distribution, encourages purchases.
Additional factors affecting competitiveness
Several elements influence a country's overall competitiveness, impacting production efficiency and market appeal.
Real exchange rates and relative inflation rates
Real exchange rates adjust nominal rates (set by foreign exchange markets) for domestic and foreign price levels, affecting export prices and competitiveness. For instance, a strong domestic currency makes exports more expensive abroad, reducing demand.
Where:
- Nominal exchange rate = Market-determined rate between currencies
- Price level in a country = Domestic inflation or cost index
- Price level abroad = Foreign inflation or cost index
Changes in nominal rates or higher foreign inflation can lower the real exchange rate, making exports cheaper.
Productivity influences
- Human capital - Improved through education and training, leading to more efficient workers.
- Capital equipment - Advanced tools and machinery increase output per worker.
Wage costs and non-wage costs
- Wage costs - Direct payments to employees; lower wages can reduce production costs.
- Non-wage costs - Additional expenses like employers' national insurance, pension contributions, and compliance with environmental, anti-discrimination, or health-and-safety laws, all raising overall costs.
Labour market flexibility
A flexible labour market allows quick adaptation to business needs, such as shifting workers between roles. Factors include trade union influence, worker skills, ease of hiring/firing, and acceptance of part-time or flexible contracts.
Research and development
Innovation through research creates new products, markets, or efficient production methods, providing a competitive edge.
Regulation impacts
Excessive regulations increase firm costs, forcing higher prices and reducing international appeal.
Worked example - Calculating real exchange rate
Suppose the nominal exchange rate between the pound and the euro is £1 = €1.08. The price level in the UK is 115, and abroad (in the eurozone) it is 120. Calculate the real exchange rate.
Step 1: Identify the values
- Nominal exchange rate = 1.08
- Price level in a country (UK) = 115
- Price level abroad (eurozone) = 120
Step 2: Apply the formula
Step 3: Perform the calculation
Government policies to improve competitiveness
Governments use supply-side policies to enhance firm efficiency and national competitiveness, though implementation can be time-consuming, costly, or controversial.
Supply-side policies for competitiveness
- Education and training improvements - Initiatives like apprenticeships build practical skills and qualifications, boosting productivity, reducing unit labour costs, and increasing occupational mobility.
- Labour market flexibility enhancements - Reforms weakening trade union powers or easing redundancies help firms adapt quickly during economic challenges.
- Investment incentives - Tax reductions for reinvesting profits encourage spending on research, improving product quality and efficiency.
- Infrastructure development - Upgrades to transport or communication networks reduce operational costs.
- Red tape reduction - Removing unnecessary regulations, such as outdated environmental rules, lowers costs and promotes entrepreneurship by simplifying business startups.
- Competition promotion - Deregulation and privatisation increase market efficiency by eliminating inefficiencies in nationalised industries.
- Immigration encouragement - Attracting skilled foreign workers quickly adds human capital.
- Economic stability maintenance - Controlling inflation, exchange rates, and balance of payments fosters a reliable environment for business.
Direct methods to influence prices
- Currency devaluation - Reducing a currency's value makes exports cheaper and imports costlier, boosting domestic demand and balance of payments, though it risks cost-push inflation and reduced efficiency incentives.
- Interest rate adjustments - Lower rates can depreciate the currency (in the UK, set by the Bank of England, not the government).
- Tariffs and subsidies - Tariffs raise import prices, while subsidies lower domestic production costs, aiding local firms but potentially discouraging long-term efficiency gains.
Advantages and disadvantages of international competitiveness
High competitiveness generally benefits economies but can have drawbacks, while declining competitiveness poses serious risks.
Benefits of strong competitiveness
- Increased export demand raises aggregate demand, drives economic growth, and boosts employment.
- Corrects current account deficits by raising exports and lowering imports.
Consequences of falling competitiveness
- Worsening balance of payments due to declining exports and rising imports.
- Reduced economic activity leading to higher unemployment.
- Challenges for industries dependent on global trade for economies of scale.
Downsides of excessive competitiveness
- Worsens current account surpluses by making exports too cheap.
- Over-reliance on exports exposes economies to external shocks, like recessions in trading partners.
- Pursuit of competitiveness may create worker insecurity through flexible labour markets or neglect environmental concerns, such as higher pollution levels.