What Determines International Competitiveness of the Economy?

The goal of this book is to establish what determines international competitiveness of countries and to investigate the veracity of several prospective answers to that question. The first possible source of international competitiveness can stem from the relative price channel. According to this hypothesis, the increase in prices would lead to a deterioration of international competitiveness of a country. Although this explanation seems to be very intuitive, it does not account for the variety of other plausible sources of international competitiveness. The price itself might not be the crucial factor that decides whether a country strengthens its international position. The second potential source of competitiveness results from technological capacity and the quality of human capital of a country. From a more general perspective, investments that lead to the technological or educational transformation of the economy can also be a vital source of (comparative) advantage. As a result, factors affecting decisions on investment and savings, such as credit availability or general government debt or budget balance, can also have a profound impact on international competitiveness. Another compelling hypothesis focuses on the importance of institutions quality. Last but not least, establishing the critical determinants of international competitiveness poses another important research question: is there a universal set of its determinants for all the countries. It might be the case that vital determinants of international competitiveness among the developed countries are somewhat different from those in emerging economies.

From the technical point of view, I attempt to understand international competitiveness of the countries within the panel data regression framework. Using panel data allows comparison not only between the countries but also observing the differences in their relative positions in time. As a result, it enables the identification of factors that shape international competitiveness, because one can observe countries that managed to improve their position. Since the economic literature provides different explanations regarding the critical determinants of international competitiveness of a country, I propose the Bayesian model averaging (BMA) framework for the purposes of this analysis. The main advantage of the BMA approach is that ←13 | 14→it allows to estimate all the possible models for the given combinations of available variables instead of a single model. For each model in the BMA framework, there is a posterior probability measure that this model reflects the true data generating process. On this basis, I can also obtain the posterior inclusion probability for each variable, which is a straightforward measure of variables’ importance. The details of this approach are presented in chapter 2.

The selection of competitiveness measures and identification of its potential determinants requires understanding what the competitiveness is. The main problem is that international competitiveness is extremely hard to define in the context of a country Boltho (1996). Some definitions of international competitiveness focus on productivity. For example, the World Economic Forum writes that economic competitiveness is “the set of institutions, policies and factors that determine the level of productivity of a country.”¹ However, it might be argued that this definition is not complete. For example, Fagerberg (1988) noted that a country cannot increase its productivity per se, so it focuses on the realisation of economic policy goals, such as increasing GDP or employment levels.

Economists such as Magaziner and Reich (1982); Tyson (1992); Reich (1992) view competitiveness through a mercantilist lens, which means that the whole economy can be viewed in the same way as a company. In such a case, each country is competing against other countries and aiming at increasing the trade surpluses that are viewed as a country (and losses can be measured in terms of trade deficits). In this framework, a persistent trade deficit leads to the deindustrialisation of the economy. For example, a surge in imported manufactured goods results a decline in manufacturing employment (as the work is shifted towards other countries) and real wages. A potential solution to the country’s competitiveness would be an industrial policy that encourages the active role of the government related to funding for education and worker training programs and increasing cooperation between the government and the private sector.

In addition to this, there is also a strand of literature that focuses on exchange rates that could be a simpler way of increasing the price ←14 | 15→competitiveness of the economy Dornbusch (1996). The key question remains whether the devaluation of the domestic currency can be an effective tool of economic policy? In theory, devaluation of domestic currency should support the exporters (as their products become cheaper) and reduce imports (see, e.g. Chinn, 2006, for a discussion of competitive devaluations).

Nevertheless, concerning on other economic issues (such as inflation, budget deficits etc.) can also lead to wrong policies and therefore I believe that understanding the factors that affect external balances of the economy can lead to better understanding the overall economic condition and help in developing reasonable policies that support further growth. Moreover, the problems with international competitiveness often are the result of poor structural policies, Llewellyn (1996). Focusing on the economic policy goals, in turn, creates another challenge, which is avoiding macroeconomic imbalances that could lead to a destabilisation of an economy. The discussion on the importance of macroeconomic imbalances leads to the first measure of competitiveness analysed in this book, namely the current account balance. In my opinion, it is the most general measure, as it describes whether a country increases or decreases its net international investment position. The second analysed measure is more specific and is based on the export market share, defined as the share of exports of a given economy in the value of global exports. I chose this measure as it becomes increasingly important due to the growing trade openness of economies (understood as the value of their trade in relation to GDP) resulting from globalisation. The exchange rate is the last competitiveness variable analysed in this work. It ←15 | 16→can be viewed as a measure directly connected to the relative price channel mentioned at the beginning of this chapter.