Competiveness in a global economy

Measuring and improving national competitiveness

Session 7bMacroeconomic Concepts and Issues

MSc Economic Policy StudiesAlan Matthews

Lecture objectives

• Discuss the role of other price and non-price factors affecting Irish competitiveness

• Introduce some important indicators used in assessing a country’s competitiveness

• Reflect on elements of a policy to restore Irish competitiveness

Competitiveness

• The ability of an economy to achieve and sustain sufficient presence in markets subject to international competition to ensure full employment and living standards

• Contested concept– Some economists argue that living standards are

solely a function of domestic productivity growth, full stop (i.e. not relative to other countries)

– However, for small open economies (‘regional economies’) the key issue is being able to attract and retain sufficient economic activity to be able to generate sufficient job opportunities

Competitiveness definitions

• ‘the set of institutions, policies and factors that determine the level of productivity of a country”– World Economic Forum

Measurement of competitiveness

• Price competitiveness• Cost competitiveness

– Labour costs – Unit Labour Costs in a common currency

– Non-labour cost measures

• Non-price competitiveness measures• Survey comparisons

– World Economic Forum Global Competitiveness Index

Consumer price level

• Not a direct measure of competitiveness, but influences competitiveness directly (tourism) and indirectly (through effects on wages)

• If prices are out of line with our trading partners, creates incentive for Irish retailers to import products rather than sell domestically produced goods

• In 1999 Irish prices 6% above the EU average, now 22% above

• Since introduction of euro to 2007, Irish inflation has averaged 3.5% pa, compared to euro area average of 2.2%

• Difference is particularly due to higher services inflation

Comparative price levels between EU member states, 2007

Source: Eurostat

Changes in price level (comparative inflation rates)

• Inflation measured using CPI (Consumer Price Index ) or HICP (Harmonised Index of Consumer Prices)– HICP covers around 90% of CPI expenditure– Main difference is exclusion of mortgage interest

relief and some differences in definition of insurance

• Distinction between headline and ‘core’ inflation – deducts energy and sometimes food

Source: NCC, Annual Competitiveness Report Vol 1, 2010

FOOD

Recap – Harmonised Competitiveness Indicator

• Real exchange rate – shows trend in relative price levels expressed in a common currency– An excessive price level (when prices are higher than justified by

economic fundamentals) affects competitiveness and results in lower output and employment

• Conventional price HCI uses consumer prices as the deflator. • Criticised because

– Does not take into account prices of intermediate and capital goods– Indirect taxes and price controls can give a distorted view– Inclusion of non-traded goods and services distorts measure of

international competitiveness

• Other deflators are possible (see later)

Source: NCC, Annual Competitiveness Report 2010

Wage and labour costs

• Wage vs labour costs– Difference is employer social security and

pension contributions

• Irish labour costs around the EU average though they have risen rapidly– Irish labour costs up 40% between 2000 and

2006 compared to 16% for EU15 and euro area

Productivity growth

• If higher growth in labour costs reflects higher growth in productivity, competitiveness does not suffer– But ex post figures may mislead if the rise in

labour costs drives low-productivity businesses out of existence

• While Irish productivity levels are close to OECD average, growth rates have been falling

Unit labour costs take both earnings and productivity growth into account…

Note how Chemicals greatly influences the trend in manufacturing ULC

Also trends elsewhere in non-manufacturing not as favourable

Source: Central Bank Quarterly Bulletin

… but heavily influenced by compositional effects

Unit labour costs in common currency terms

• Incorporates the effects of both wage and productivity growth in Ireland relative to Ireland’s trading partners as well as exchange rate movements

• Calculated as wages / labour productivity• During the 1990s relative ULC in common

currency declined, signifying gains in cost competitiveness.

• Since 2002, increase in ULC in common currency has been around 25% economy-wide

• An alternative measure of relative competitiveness to the real HCI deflated by Consumer Price Index

See Box A, CB Quarterly Bulletin No 1, 2011 pp. 22-24 for a discussion of how this cost competitiveness index is influenced by compositional effects.

The apparent sharp fall in manufacturing ULCs due to increase in importance of high value added but low employment modern sectors between 2008 and 2010

Taken from O’Brien CBQB No 1, 2010. This series is not regularly updated by the CB due to data difficulties

General business costs

• Benchmarked annually in the NCC Annual Competitiveness Reports

• Examples– Property costs, utility costs, IT, accountancy

and legal services, waste and professional services

Non-price elements of competitiveness

• Business environment – labour force skills, quality of entrepreneurship,

tax system, physical and knowledge infrastructure, labour and product market regulation, access to finance

• Technological competitiveness– Innovative and adaptive capacity of economy

Competitiveness surveys

• World Economic Forum Global Competitiveness Index– The GCI is compiled from 113 different indicators,

divided into twelve “pillars” of competitiveness (education, efficiency of labour and product markets, business sophistication, innovation, etc.)..

– The relative weights given to these indicators vary depending on each country’s level of development.

– Strong emphasis on business leaders’ opinions results in some strange individual rankings

• See critique on Irish Economy blog

Restoring Irish competitiveness

• National Competitiveness Council Annual Competitiveness Report Vol. 2– Investment priorities– Taxation policy to support competitiveness– Lowering costs of doing business– Education and skills

• Building Ireland’s Smart Economy– Download

• Addressing cost competitiveness without the possibility of devaluing the currency– Forfás Restoring Labour Cost Competitiveness 2010– Achieving an internal devaluation– How important are wage costs to competitiveness?

Review and conclusions

• Irish competitiveness a function of productivity, cost and exchange rate developments

• We have learned how to measure cost competitiveness using the HCI deflated by either consumer prices or unit labour costs

• Global competitiveness rankings assess a wider range of competitive capacities

• For Ireland, exchange rate movements of the euro are particularly important driver of changes in competitiveness

• Policies to restore competitiveness in short and longer runs

Web sources

• National Competitiveness Council, Annual Competitiveness Reports

• DG Enterprise and Industry, European Competitiveness Reports

Follow up and reading

• O’Brien, D., 2010, Measuring Ireland’s price and labour cost competitiveness, Central Bank Quarterly Bulletin No. 1.

• Cassidy, M. and O’Brien, D., 2007. Ireland’s competitiveness performance, Central Bank Quarterly Bulletin No. 2.