4.1.9 International Competitiveness

Question 1

What is competitiveness?

Answer 1

External competitiveness is the sustained ability to sell goods and services profitably at competitive prices overseas.

Question 2

What is the key measure of price competitiveness?

Answer 2

Differences in relative unit labour costs (ULCs)

Question 3

What is the key measure of non-price competitiveness?

Answer 3

Product quality, innovation, design, reliability and performance, choice, after-sales services,
marketing, branding, brand loyalty and the availability and cost of replacement parts

Question 4

What do non-wage cost factors include?

Answer 4

1. Environmental taxes e.g. minimum prices on carbon emissions
2. Employment protection laws & health and safety regulations
3. Statutory requirements for employer pensions
4. Employment taxes e.g. employers’ national insurance costs.

Question 5

What are unit labour costs?

Answer 5

Unit labour costs are labour costs per unit of output. There is a simple formula for calculating unit labour costs:
Unit labour costs = total labour costs / total output

Question 6

What are unit labour costs determined by?

Answer 6

1. Average wages / salaries in a country’s labour market – one measure tracked is the hourly labour cost of
   employing people in the labour market
2. Labour productivity i.e. output per person employed or output per hour worked

Question 7

What happens to unit labour costs when wages are rising faster than productivity?

Answer 7

Unit labour costs will tend to rise when wages are rising faster than productivity

Question 8

When does relative unit labour costs rise?

Answer 8

o A country’s exchange rate appreciates
o Wage costs rise relatively faster than other nations
o Labour productivity growth is relatively slower

Question 9

What are options of reducing relative unit labour costs?

Answer 9

o Monetary policy interventions aimed at a currency depreciation e.g. a managed floating exchange
rate
o Wage controls e.g. wage/pay freezes in the public sector
o Supply-side measures designed to raise labour productivity / efficiency across many industries

Question 10

What are relative export prices?

Answer 10

Relative export prices are one country’s export prices in relation to other countries, usually expressed as an index.

Question 11

Explain the times when relative export prices rise

Answer 11

1. There is an appreciation of the currency – causing export prices in overseas markets to rise
2. There is a period of high relative inflation in one country compared to others – again this tends to make
   exports appear more expensive when priced in an overseas currency
3. When export businesses experience higher costs e.g. arising from environmental taxes, increased minimum
   wages which leads them to raise price to protect their profit margins
4. When exporters of goods and services are hit by import tariffs

Question 12

What are policies to improve competitiveness?

Answer 12

1. Competitive exchange rate – perhaps involving a managed floating currency
2. Competitive tax environment to attract inward investment and encourage new business start-up’s
3. Investment in human capital to improve the quality of the workforce
4. Increased research & development to drive a faster pace of innovation
5. Stronger market competition to raise factor productivity and lower relative export prices
6. Stable macroeconomic environment e.g. maintaining low inflation with steady economic growth to support
   business confidence
7. Investment in critical infrastructure such as better road, air and rail links, improved ports, faster broadband
   and fibre-optic internet connections

Question 13

List reasons for how fiscal policy can drive competitiveness of countries

Answer 13

1. Subsidies to lower the cost of research e.g. in pharmaceuticals, life sciences, robotics and artificial intelligence
2. Tax incentives can encourage the commercialisation of ideas e.g. ideas coming out of universities
3. Lower employment taxes to stimulate skilled migration from overseas
4. Lower capital gains taxes encourage small businesses / start-ups
5. Special economic zones (SEZ) to attract research-intensive businesses

Question 14

What are the benefits of international competitiveness?

Answer 14

o Improved living standards e.g. measured by real GNI per capita (PPP)
o Stronger trade performance from an increase in export sales
o Virtuous circle of economic growth
o Employment creation
o Higher government tax revenues

Question 15

What are the problems of international competitiveness?

Answer 15

o Trade surpluses might invite a protectionist response
o Possible risks of demand-pull inflation
o Competitiveness might be achieved at the expense of growing inequality of income and wealth
o Higher productivity might be achieved at expense of a worsening work-life balance and increased
incidence of mental health problems
o Increased competitiveness might cause a country’s exchange rate to appreciate

Question 16

What is an internal devaluation?

Answer 16

• Internal devaluation happens when a country seeks to improve price competitiveness through lowering their
  wage costs and increasing productivity and not reducing the external value of their exchange rate.
• Good examples in recent years have applied to Latvia (a Baltic State) and Greece, in the wake of a severe
  depression which followed the Global Financial Crisis. Ecuador is also implementing internal devaluation

Question 17

Explain what internal devaluation should require

Answer 17

• An internal devaluation requires several years of low relative inflation i.e. a country’s inflation rate lower than
  price increases in other countries. With Greece, this involved price deflation i.e. a negative rate of inflation.

Question 18

How can an internal devaluation be brought about?

Answer 18

Internal devaluation can be brought about by fiscal austerity (via higher taxes and cuts in government
spending) and/or a sharp rise in real interest rates – both impose deflationary pressure on output & prices.

Question 19

When is internal devaluation more likely to happen?

Answer 19

Internal devaluation is more likely to happen with a country that has a fixed exchange rate e.g. Ecuador has
a fixed rate against the US dollar. Greece is inside the Single European Currency zone and cannot devalue
unilaterally.

Question 20

What is an external devaluation?

Answer 20

• An external devaluation happens when a country operating with a fixed or semi-fixed exchange rate system
  decides to deliberately lower the external value of their currency against one or a range of other currencies.
• A devaluation of the currency means a domestic currency buys less of a foreign currency. One motivation is
  to make exports more price competitive in overseas markets and to make imports relatively more expensive
  than domestic supply.

Question 21

What are examples of countries who’ve devalued?

Answer 21

• Examples of countries that have devalued in recent years include Egypt (a 16% fall v the US$ in 2016) and
  Ghana whose currency was devalued by 17% against the US$ in 2019.

Question 22

What are the risks of an internal devaluation?

Answer 22

1. Severe loss of output and rising unemployment
2. Fall in nominal wages reduces living standards
3. Risks from sustained price deflation
4. Real value of debt increases
5. Danger of a country suffering a permanent loss of output (known as “hysteresis”)

Question 23

What are the risks of an external devaluation?

Answer 23

1. Increase in cost-push inflation from higher import prices
2. Reduces real incomes because of a rise in inflation
3. No guarantee that the trade deficit will improve (refer to the J Curve concept)
4. Foreign creditors will demand higher interest rates on new issues of government & corporate debt
5. Currency uncertainty makes country less attractive to inward FDI