The “filter” model of the competitiveness of an

inter-national trade. According to the WTO, “trade is distorted if prices are higher or lower than normal, and if quantities produced, bought and sold are also higher or lower than normal – i.e. than the levels that would usually exist in a compe-titive market” (WTO 2010). These measures include various trade restrictions to imports such as tariffs and quotas, export subsidies and other methods used to make exports artificially competitive, and domestic support that has a direct effect on production and trade by raising or guaranteeing prices and income for producers.²⁸

Factors internal to an industry coupled with uncontrollable factors and fac-tors controlled by governments that do not distort trade determine the potential of competitiveness, meaning a competitive advantage that makes the products of a national industry vis-à-vis foreign competitors more appealable to custo-mers – either through their price advantage or quality – and that potentially helps the industry to increase its profits – either through its cost or productivity advantage or a superior technology. These measures can hence be called the

“real” determinants of competitiveness.²⁹

28 In WTO terms, government services such as research, disease control, infrastructure, food security, direct payments under environmental and regional assistance programmes are forms of government support which do not have a direct impact on production and trade, and are, hence, not trade distorting (WTO 2010).

29 Similarly, Siggel (2001, 2003) distinguishes between two groups of factors: the “real”

sources of competitiveness (which determine comparative advantage) and distortions in the prices of products and factors of production, which determine competitive advan-tage. These distortions are often policy-induced (e.g. subsidies, market price premia and exchange rate misalignments), and may either enhance or diminish competitiveness.

According to Pitts and Lagnevik (1998), comparative advantage refers to whether a country can produce and sell products in domestic and foreign markets without government subsidies (Pitts, Lagnevik 1998: 3).

Figure 1.4. The system of the determinants of competitiveness in the food processing industry (author’s figure based on Abbott, Bredahl 1994; Martinet al. 1991; Porter 1990; Rugman, Verbeke 1990; Schiff, Valdes 1998) THE DETERMINANTS OF COMPETITIVENESS OF THE FOOD PROCESSING INDUSTRY FACTORS INTERNAL TO THE INDUSTRYFACTORS EXTERNAL TO THE INDUSTRY FIRM-SPECIFIC FACTORS Strategy Products Technology Own R&D Training Costs Links Knowledge base Managerial expertise

FACTORS BEYOND THE FIRM LEVEL Industry structure Rivalry and cooperation Producer associations Lobby groups Links to related and supporting industries FACTORS CONTROLLED BY DOMESTIC GOVERNMENT Regulations/ standards Trade policy Agricultural policy Environmental policy Macroeconomic policy Infrastructure R&D policy Education and training FACTORS CONTROLLED BY FOREIGN GOVERNMENTS Access to foreign markets (product standards, import tariffs, quotas, etc) Import competition (support to producers, export subsidies) QUASI- CONTROL- LABLE FACTORS World market prices (input, output) Exchange rate movements Demand conditions Country of origin effect UN-CONTROL- LABLE FACTORS Climate Factor endow- ments Natural resources Distance from the main world markets

Trade-distortive public policy measures, on the other hand, constitute a “filter”

which determines whether this competitiveness potential will materialise into an actual competitiveness performance or not (see Figure 1.5). In other words, government policies can help (or impede) transform competitive potential – which is itself based on “real” drivers of competitiveness such as relative cost level, productivity, technological progress – into actual competitiveness performance.

Figure 1.5. The “filter” model of competitiveness (author’s figure)

In particular, governments’ choice of foreign trade policy can have a significant impact on an industry’s competitiveness in domestic and export markets. For example, a country may possess strong competitiveness potential due to its cost and technological advantage, but if foreign countries protect their domestic markets with extensive trade barriers, this potential may not materialise as actual competitiveness performance. Similarly, if a domestic government does not use any counter-balancing measures to protect its domestic market from subsidised imports, this can impede the domestic industry from realising its competitiveness potential on the domestic market. On the other hand, an industry that does not possess any significant competitiveness potential may gain foreign markets with the help of export subsidies, even though this raises the question of whether this competitiveness is sustainable over the long term.

These examples show the direct effect of policies on the competitiveness of an industry.

However, the same policies can have an indirect effect on the competitive-ness of an industry via affecting the incentives of firms belonging to the industry. For example, Ezeala-Harrison (1999) discusses the role of alternative trade policies for the international competitiveness of firms. The author diffe-rentiates between three types of strategic trade policies, which are called inner-orientation (import substitution), outer-inner-orientation (export substitution) and inner-outer orientation (regional integration) trade policies. The author shows that an import substitution trade policy that includes the taxation of imports with tariffs contradicts the achievement of international competitiveness since

COMPETITIVENESS

POTENTIAL COMPETITIVENESS

PERFORMANCE

”REAL” FACTORS OF COMPETITIVENESS

Trade-distorting public policies

52

the country’s products would have a greater import-competing ability with foreign products on the domestic market. Tariffs raise the prices of imports, which lessens the incentive of import-competing industries to achieve greater efficiency of operation. Furthermore, the inner-orientation policy would most probably lead to retaliations from trading partners and hence impair export possibilities. Instead, “a domestic firm must be exposed to import competition to enable it to develop a necessary comparative advantage” (Ezeala-Harrison 1999: 143). This aspect can be carried over to industry level – an industry must be exposed to import competition in order to become more competitive. Ezeala-Harrison (1999: 144) concludes that the best trade policy for a country, in order to gain and maintain international competitiveness, is the policy of open and unrestricted international trade.

This shows that a trade policy measure, which direct effect on the competi-tiveness of an industry is positive, can have a negative indirect effect on the competitiveness via changes in the incentives of firms belonging to the industry, and vice versa. Other examples of policies impeding competitiveness em-phasized in economic literature are protective measures and government sub-sidies to some economic sectors, which lead to social costs and market distortions (Hyvönen, Kola 1998: 258).

Furthermore, government subsidies, import tariffs and other restrictions can, although artificially, raise a domestic industry’s short-term profitability. Higher profitability, in turn, indicates higher competitiveness. This shows the contro-versial nature of the impact of trade policy on competitiveness measured in terms of profitability. Still, in the long run, exposure to import competition and the concurrent increase in efficiency can outweigh the short-run positive impact of import barriers on profitability.

On the other hand, if a country is applying unilateral free trade, while its domestic industry is faced with tariffs and other trade barriers on its exports to partner countries, it liberally sets its industry in a worse situation than its co-unterparts abroad. Furthermore, the situation is worsened if the trade partners support their industries while the domestic government does not intervene.

Hence, trade policy should not be passive; it should seek to open new markets in other countries and address emerging industries and possible problems.

According to Porter (1990), when domestic exporters are faced with trade barriers in another country, the government should strive to dismantle the barriers rather than regulate imports or exports. Yet, this strategy may be more suitable for a large high-income country with high negotiation power in inter-national affairs. A small country, however, may not be able to influence poli-tical decisions in other countries, and then the country should rather adopt countermeasures to protect national industries against unfair competition.

As discussed above, the competitiveness of an industry is also reflected in its ability to adapt to the changing economic and political environment, which can foster its ability to gain product markets, and consequently, earn profits. An example of a changing environment, which can alter the determinants of compe-titiveness, is the integration of a country into an economic union, such as

acces-sion to the Single Market of the EU. This aspect is touched upon in the next Chapter.

1.2.2. Economic integration as a determinant of the international