A Critical View of the Competitiveness Concept at the Macro-Level

Criticism of the macro-interpretation comes first from those who do not believe that countries compete in the same sense as firms. From the theoretical point of view, Paul Krugman (1994) criticizes a general definition of competitiveness regardless of the unit of analysis, but especially when the term uses nations as the unit of analysis at the macro-level. He says that the term “productivity” was already used to compare countries’ performance, and that “competitiveness” is just an odd way of restating this.

The debate of the competitiveness concept at the macro-level began in the mid 1990s with a series of discussions on the meaning of competitiveness, with the nation as the unit of analysis. Foreign Affairs Magazine (1994) published a series about the competitiveness debate in which Paul Krugman published “Competitiveness: A Dangerous Obsession”, one of the most-quoted essays on the meaning of competitiveness. The same series included essays from Prestowitz, Thurow, and Cohen against Krugman supporting some of the fundamentals of the traditional competitiveness approach. The debate described below considers these divergent positions.

Table I.1. Measurements of Competitiveness at the Macro-Level

Measurement Conceptual Background Author’s Contribution Author’s Criticism Quantitative Indicators

Balance of Payments

“An economy’s ability to grow and to raise the general living standards of its population in a reasonably open trading environment without being constrained by balance of payments difficulties” Haque (1995, p. 17-18). ^a

Note “…reasonably open trading environment…”: there is a slight emphasis on the possibility of achieving competitive advantage without necessarily a free trade environment.

There are additional internal determinants (e.g., quality standards) that can affect competitiveness and are not recognized by balance of payments measurements.

Trade Performance

“Competitiveness... is the degree to which a country can, under free and fair market conditions, produce goods and services which meet the test of international markets, while simultaneously maintaining and expanding the real incomes of its people over the long term…

Competitiveness at the national level^b is based on superior productivity performance” U.S.

Presidential Commission on Industrial Competitiveness (1985, p. 1) ^c.

Demand-based measurement. As will be shown in the second chapter, demand is one of the main determinants to take into account in models of competitiveness.

-Fair and free trade can have contradictory effects on competitiveness.

-According to this definition, competitiveness and productivity seem to be synonymous at the nation unit.

-Trade surplus does not necessarily mean a strong economy if, for example, the surplus is used to pay the interest on a country’s foreign debt.

Real Exchange Rate (RER) ^d

“According to foreign trade theory, improvements in the balance of current account will ceteris paribus result in an appreciation of the domestic currency in nominal and real terms… The degree of appreciation of the domestic currency in the RER indicates to what extent international competitiveness has increased” Frohberg & Hartman (1997, p. 9-10).

The availability of RER indicators among countries eases international comparison.

Any measurement that implies comparison between countries must be converted to a common value by means of the RER .

RER changes in recent decades are the result of capital movements rather than changes in the basic conditions of the real economy.

Price controls and other distortions can cause “noise” in the performance of the indicator.

“A country is internationally competitive when it devotes relatively more resources measured by expenditures or personnel to R&D activity compared with other countries. It lacks international competitiveness compared with foreign countries to the extent that its R&D efforts falls behind other countries” (Bloch &

As a qualitative indicator, R&D is by itself a contribution to a comprehensive definition of competitive advantage.

Expenditure on R&D should deal with strategic trade policy, according to recent competitiveness theory literature.

No data on expenditures can provide an accurate measure of the effectiveness of R&D efforts. Some countries focus most R&D resources on defense, which do not necessarily contribute to competitiveness (Cohen 1995, p. 25).

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Kenyon 2001, p. 26) In addition, comparisons among countries are limited to the availability and methodology of dealing with competitiveness of a country are, for the WEF, (2002, p. 2) “the set of institutions, policies and regulations that support high levels of productivity and drive productivity growth and sustained increases in output. Competitive countries can be expected to return to a sustained growth path faster and earlier than those that are less competitive.”

This definition is emphasized by the International Institute of Management and Development (IMD): “Nations compete because world markets are open”, the IMD competitiveness indicators

“analyzes and ranks the ability of nations to provide an environment that sustains the competitiveness of enterprises” (IMD 2002, http://www02.imd.ch/wcy/fundamentals)

This is not a definition of competitiveness by itself but of the macroeconomic environment that influences competitive advantage.

Both WEF and IMD indicators are based on relatively recent surveys, so it is not possible to have a long-period study of the trends of competitiveness environment.

There is an emphasis on the role of institutions as an engine for competitiveness.

In particular, the WEF indicators lack a constant methodology, and change almost every year.

a See also Fanelli & Meldhora (2002, p. 10) and Fagerberg (1988, p. 355)

b Note the distinction between unit and level of analysis. For this case, “unit”, rather than “level”, would be preferable, but I did not change the original definition.

c Ronald Reagan established the President’s Commission on Industrial Competitiveness on June 28, 1983. Reagan designated John A. Young, former president of Hewlett-Packard Co., chairman of the commission. One of the members of that commission was Michael E. Porter. See: Statement on Establishment of the President’s Commission on Industrial Competitiveness, August 4, 1983. http://www.reagan.utexas.edu/resource/speeches/1983/80483c.htm

d The RER is defined as the ratio of the price of tradable commodities to that of non-tradable ones. The costs of producing a tradable good differ between countries, mainly because of the varying prices of non-tradable inputs used in producing the commodity, and to a lesser extent, due to tradable inputs. Due to the lack of statistics on prices for non-tradables, the RER is usually approximated by some ratio of foreign to domestic price indexes (e.g., purchasing power parity, consumer price index, implicit GDP deflator, export unit values, unit labor costs). See also: Wignaraja (2003, p. 16-17); Marsh & Tokarick (1996, p. 700-721); Stanton (1986, p. 15-18) and Dunmore (1986, p. 31-32)

I. CONCEPTS AND MEASUREMENTS OF COMPETITIVENESS

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Krugman, as the main critic of the competitiveness concept, states: “competitiveness would turn out to be a funny way of saying productivity” (Krugman 1994, p. 32); “we would like to believe that if famed intellectuals and powerful politicians talk about competitiveness, they must have something meaningful in mind. It seems far too cynical to suggest that the debate over competitiveness is simply a matter of time-honoured fallacies about international trade being dressed up in new and pretentious rhetoric. But it is” (Krugman 1996, p. 24). He explicitly argues that the concept is a consequence of political rhetoric quoting two politicians. The first was Jaques Delors, former President of the European Commission, who stated in June 1993 that “the root cause of European unemployment was a lack of competitiveness with the United States and Japan and that the solution was a program of investment in infrastructure and high technology”

(Krugman 1994, p. 28). Second, US President Bill Clinton said “each nation is like a big corporation competing in the global market” (Krugman 1994, p. 28). According to these statements competitiveness is possible for countries as well as companies, and with regard to the classification of Section I.2.1, would be classified at the macro-level. But Krugman (1994) strongly criticizes this position, arguing that countries do not compete because they “do not go out of business. They may be happy or unhappy with their economic performance, but they have no well-defined bottom line. As a result, the concept of national competitiveness is elusive” (Krugman 1994, p. 30).

Krugman’s second criticism is that politicians “naively” define a national economy’s competitiveness as its trade balance (see Table I.1). A surplus in the trade balance is not necessarily sign of an economy’s strength, for example, if it a country has to run trade surpluses in order to pay for its foreign debt. Krugman quotes authors that realize this problem and add other measurements in an attempt to repair the definition. For instance, Tyson (1992)¹¹ includes an increasing standard of living: “competitiveness is our ability to produce goods and services that meet the test of international competition while our citizens enjoy a standard of living that is both rising and sustainable”, and Magaziner and Reich (1982)¹² includes factors of productivity: “our standard of living can only rise if (i) capital and labor increasingly flow to industries with high value-added per worker

11 Quoted in Krugman (1994 p. 31) This definition was included in the First Report of the Competitiveness Policy Council during the administration of Bill Clinton. “Building a Competitive America”, First Annual Report to the President and Congress, March 1, 1992.

12 Quoted in Krugman (1994:36) from Ira Magaziner and Robert Reich’s “Minding America´s Business” (1982).

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and (ii) we maintain a position in those industries that is superior to that of our competitors”.

Krugman challenges both criteria. First, against Tyson’s definition, he argues that this competitiveness concept could only be useful if trade is meaningful as a measure of the GDP. If not, domestic productivity should be enough to define it. Furthermore, he asks, if it is accepted that trade is representative, what would be the result of a permanent devaluation leading to cheaper goods and services. Effectively, this would increase exports while possibly lowering the standard of living, which depends on the purchasing power of imports and domestically produced goods. Thus, Krugman states, “domestic growth might be outweighed by deteriorating terms of trade. So 'competitiveness' could turn out really to be about international competition after all” (1994, p. 32-33).

Regarding the Magaziner and Reich statement, Krugman questions the selection of the sector from which the productive factors would be measured. Krugman states that value-added industries are generally capital intensive and must earn normal returns on large investments. However, these returns do not necessarily transfer into increased living standards, but may also be used for new investments in capital. If one accepts Magaziner and Reich’s definition, there is no reason to address productive factors in capital-intensive industries. Krugman suggests that perhaps Magaziner and Reich should have proposed high-technology instead of value-added industries.

In conclusion, to Krugman, the competitiveness concept does not make any sense at all, and even seems “dangerous” if advocated with the nation as unit of analysis in order to support trade policies.