What Really Is Competitiveness?

If you want to advance any particular policy position these days, here is a piece of advice. Claim it will boost your nation’s economic competitiveness. This at least assures you a hearing.

But what is competitiveness? The term is almost always defined incorrectly – and no one has actually ever accurately measured national competitiveness.

Some, like the European Commission, in its 2012 European Competitiveness Report don’t even define competitiveness. Others do so incorrectly, as Harvard’s Michael Porter does when he states, “the only meaningful concept of competitiveness at the national level is productivity.”

The World Economic Forum’s Global Competitiveness Report agrees, defining competitiveness as “the set of institutions, policies and factors that determine the level of productivity of a country.”

Competitiveness is not the same as productivity

But competitiveness is not the same as productivity. To see why, it is important to differentiate between traded and non-traded sector industries. A traded industry is one where the firms sell a significant share of their output outside a particular nation.

A software firm in the U.S. state of Washington that sells software throughout the world would be a traded firm. A local retail hardware store would be a non-traded firm.

Thus, competitiveness relates only to the economic health of a nation’s traded sectors. A nation could have extremely high productivity in its hardware stores and still have unhealthy traded sectors.

But how do we define economic health? One definition is jobs. However, if one nation’s traded sector is highly productive, it could have fewer jobs than another nation’s – even if the first is in fact more competitive.

A better definition is value-added. That is the amount of value that traded sector firms add to the inputs of production that they purchase. But even this measure fails to control for the size of a nation’s traded sector economy, i.e., the larger the economy the larger the impact of the value added on competitiveness.

In addition, if a nation has vastly more imports, even if its traded sectors are producing a large amount of value, its economy is not holding its own when it comes to competitiveness.

Focusing on trade deficits alone fails to account for the fact that a nation might run a trade surplus primarily but by providing “discounts” for its exporters (e.g., by undervalued currency, suppressed export sector wages, artificially low traded sector taxes, and export subsidies) as well as erecting barriers to imports (e.g., tariff and non-tariff barriers).

In this case, the trade surplus may not be a reflection of the true competitiveness of the nation’s traded sector firms. Rather, it reflects the extent of mercantilist aid and protection.

The true definition of competitiveness

Thus, the true definition of competitiveness is the ability of a region to export more in value added terms than it imports when including for “terms of trade” to reflect all government “discounts” and import barriers.

Under this definition, a nation may run a large trade surplus, but if it does so by providing large “discounts” to its exporters or erecting sizable import barriers, it would not be truly competitive.

After all, such policies reduce its terms of trade by requiring its residents to give up some of their income to foreign consumers and/or pay higher prices.

As a result, despite numerous studies claiming to compare nations on competitiveness, no study has adequately accounted for export discounting and import restricting. This is because internationally comparable data are difficult to obtain.

Despite this, at a cursory level, it would appear that nations like Austria, Germany and Sweden would be on a list of competitive economies (they run trade surpluses while also having relatively high wages and limited discounts).

In contrast, nations like China (too much discounting) and the United States (too large a trade deficit even when accounting for foreign subsidies) would likely not make the list.

So before we go off talking about competitiveness and what country leads or lags, it would be useful to have the right definition and the right data.