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International Competitiveness

Competitiveness can be defined as the ability of a country to compete on an international stage and successfully sustain improvements in wealth and real output.
A measure of competitiveness needs to be established in order to compare competitiveness amongst countries. This can be important for firms who would want to produce in the most competitive countries in order to gain from efficiencies and cheaper production (but not necessarily labour costs). Competitiveness can also be used by countries to evaluate how they can improve their balance of payments and create economic growth by coming more competitive. There isn’t a comprehensive definable measure of competitiveness; but instead a number of methods to measure it. 

There are a number of determinants for demand of UK exports in the world market. Demand for UK exports depends on the price of UK goods, the price of foreign countries’ goods, incomes in the World and foreigners’ preferences for British goods (as oppose to substitute goods in other countries). The exchange rate also plays a large part as this determines the price of UK goods to foreigners. A weak domestic currency makes exports cheaper to foreign countries; this may result in an increase in exports. A low currency makes an economy more competitive internationally. However the real exchange rate needs to be used in order to evaluate whether an economy has become more competitive or whether or not it has just been experiencing inflation. The real exchange rate shows the exchange rate with adjustments to take into account the differing inflation rates between countries.

Competitiveness can be measured using; relative unit labour costs – a comparison of labour costs obtained by converting costs into a common currency and using an index number; relative productivity – output per worker per time period; an institutional index, e.g. the Global Competitiveness Index made by the World Economic Forum with 12 pillars based on the strengths of institutions, labour market efficiency, infrastructure, financial market sophistication, macro stability, technological readiness, market size, health care and primary education, business sophistication, higher education and training, innovation and goods market efficiency.

This can be affected by the Real Exchange Rate which is the nominal (market traded) exchange rate adjusted for price levels (inflation):

A decrease in the real exchange rate means a country has become more internationally competitive and this isn’t due to domestic inflation. However the exchange rate only shows a comparison between 2 countries. A better method may be to use a Sterling effective exchange rate; this shows Sterling relative to a weighted average of exchange rates of the UK’s trading partners. Because the exchange rate is weighted it means that this measure takes into account the relative importance of the trading partner to the UK. If RER were to equal one then purchasing power parity can be said to be achieved, and the currency is perfectly set in terms of purchasing power.
Aside from exchange rates competitiveness may be determined by differing costs of production in different countries. This is reflected by the levels of productivity across countries. Unit labour cost is a measure of productivity and shows the costs of a unit of labour for a specified period of time. An increase in unit labour costs relative to foreign countries means the UK is becoming more uncompetitive. There are many issues with comparisons of productivity due to differences in data collection and cultural differences. For example an analysis of GDP per capita relative to the US shows that the UK is more competitive than both France and Germany. However this may be due to the long hours worked in the UK compared with France and Germany. An analysis of GDP per hour worked relative to the US shows that both France and Germany are more competitive than the UK (this can be resolved using comparisons including time periods worked).

Wages are the most expensive cost of production and are likely to reduce the international competitiveness of an economy. However higher productivity is usually a determinant of higher wages (as well as immigration restrictions). Non-wage costs increase the price of goods further, these include; employment taxes, regulations, employment laws and pension contributions.

Labour productivity is usually influenced by education and training levels (human capital), the amount of physical capital present, infrastructure, labour market flexibilities and research & development. Hence any one of these factors can be improved to increased competitiveness. Investment in capital equipment by firms and supply side measures undertaken by the government will have this effect.

Page last updated on 15/04/14