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What Determines International Competitiveness of the Economy?

Evidence from Bayesian Model Averaging

by Piotr Dybka (Author)
Monographs 126 Pages
Series: Polish Studies in Economics, Volume 12

Summary

This study examines the determinants of current account, export market share and exchange rates. The author identifies key determinants using Bayesian Model Averaging, which allows evaluation of probability that each variable is in fact a determinant of the analysed competitiveness measure. The main implication of the results presented in the study is that increasing international competitiveness is a gradual process that requires institutional and technological changes rather than short-term adjustments in relative prices.

Table Of Contents

  • Cover
  • Title
  • Copyright
  • About the author
  • About the book
  • This eBook can be cited
  • Abstract
  • Contents
  • Acknowledgements
  • 1 International competitiveness of countries
  • 2 Econometric methodology
  • 2.1 BMA framework
  • 2.2 Estimation within the BMA framework
  • 2.2.1 Fixed effects panel regression with Zellner’s g-prior
  • 2.2.2 Panel data with a lagged dependent variable
  • 2.3 Assumptions related to the prior size of the model
  • 2.4 Interpretation of the BMA analysis results
  • 2.5 Dynamic Bayesian model averaging
  • 3 Current Account determinants
  • 3.1 The economic theory
  • 3.2 Variable description
  • 3.3 The data
  • 3.4 Baseline results
  • 3.5 Sensitivity analysis
  • 3.5.1 Sensitivity analysis with respect to prior assumptions
  • 3.5.2 Dynamic model specification
  • 3.5.3 Result for various groups of countries
  • 3.6 Conclusions
  • 4 Export market share determinants
  • 4.1 The economic theory
  • 4.2 Variable description
  • 4.3 The data
  • 4.4 Baseline results
  • 4.5 Sensitivity analysis
  • 4.5.1 Sensitivity analysis with respect to prior assumptions
  • 4.5.2 Results on the basis of extended sets of regressors
  • 4.5.3 Does membership in the European Union affect the export performance?
  • 4.6 Conclusions
  • 5 Exchange rate determinants
  • 5.1 The economic theory
  • 5.2 Variable description
  • 5.3 The data
  • 5.4 Baseline results
  • 5.5 Sensitivity analysis regarding prior assumptions
  • 5.6 Can exchange rate determinants differ in time?
  • Determinants of the USD/CAD rate
  • Determinants of the USD/CHF rate
  • Determinants of the EUR/USD rate
  • Determinants of the USD/JPY rate
  • Determinants of the USD/GBP rate
  • 5.7 Conclusions
  • 6 Final conclusions
  • References
  • 7 Appendix
  • Index of Names
  • Series Index

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Acknowledgements

I want to thank the following people, without whom I would not have completed this research. Chapter 3 is based on the article Dybka and Rubaszek (2017) that I have written together with Professor Michał Rubaszek from SGH Warsaw School of Economics, whereas in chapter 4, I have used the results from article Bierut and Dybka (2021), published together with Beata Bierut. In addition to this, I would like to thank the Reviewers, Professor Marek A. Dąbrowski and Professor Piotr Wdowiński, for many valuable comments that substantially improved the overall quality of the book. Last but not least, I would also like to thank the Editor, Professor Ryszard Kokoszczyński, for his valuable remarks. Moreover, the book would not have been written without the encouragement from my wife, my parents and my grandparents.

This work was supported by a research subvention at SGH Warsaw School of Economics No. KAE/S21.

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1 International competitiveness of countries

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).

In contrast, Krugman (1994) calls the international competitiveness a “dangerous obsession.” Krugman (1996) criticises the mercantilist approach, as counties do not act in the same way as firms. If a firm consistently incurs losses, then it will go out of business. However, persistent trade deficits do not mean that a country goes bankrupt. A trade deficit may result from an increase in the demand for all goods in a growing economy, both domestically produced and foreign-produced (imports). Nevertheless, the main concern resulting from focusing on external economic performance is that it can lead to wrong economic policies, such as embracing protectionism or promoting their own firms at the expense of other countries’ producers Krugman (1996).

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.

In this study, I have used different databases in each chapter focusing on a particular measure of international competitiveness. On the one hand, such an approach makes direct comparisons between the results of each chapter more challenging. On the other hand, it does have some essential advantages. First, it allows the use of the most extensive dataset available, rather than estimating on the basis of largest common sample, which yields a more precise estimate. Second, such an approach also shows which conclusions can be generalised and which depend on additional factors. As a result, I have performed a sensitivity analysis of my results that allows discussion regarding the stability of the results. Third, even though baseline results in each chapter were obtained on the basis of different samples, there are some additional results presented in the sensitivity analysis that make comparisons easier. For example, comparing the results obtained on a broad panel of countries in the case of the analysis of the determinants of the current account with the results on the competitiveness of exports in the European Union countries is difficult. Nevertheless, chapter 3 also contains the results for the sub-sample of economically developed countries to which all European Union countries belong.

The structure of this book is as follows. In chapter 2, I present the methodology applied in this work. The chapter begins with an introduction of the Bayesian model averaging (BMA) framework and discussion of the key assumptions related to the choice of the estimator and the prior size of the model. Next, the interpretation of the BMA results is shown on the basis of exemplary results. Last but not least, I present additional extensions of the BMA framework that were also used in this dissertation.

Biographical notes

Piotr Dybka (Author)

Piotr Dybka is an Assistant Professor at the SGH Warsaw School of Economics. His research interests are international economics, with a particular focus on sources of international competitiveness, and public economics, especially in the context of shadow economy estimation.

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Title: What Determines International Competitiveness of the Economy?