So Now It Is All About ExportsGDP = Household Consumption + Investment + GovernmentConsumption+ Net Trade (Exports – Imports)Now if household and government consumption are fallingsystematically, the only factor which can give a direct boost to GDP is therelative movement in exports and imports. Positive movement here canstimulate investment in the export (or tradeable) sector as expectationsbuild for increased demand.Total Investment = Investment for Exports + Investment For DomesticDemand.
Just Not Sufficiently Competitive? While Italian exports surged back after the financial crisis recession they never in fact attained their pre- crisis level, and now they are once more declining again. In addition, even though Italy’s goods trade deficit has reduced substantially over the last 12 months, it is still a DEFICIT.As we can see in the chart on theright, the Italian economy was on anunsustainable path from the end of2009 to mid 2011, as excessivegovernment spending fed an importsurge. As government spending wascut this import boom burst, anddomestic demand collapsed, takingthe country deep into recession.
How To Define Competitiveness? The issue of competitiveness has become one generating more heat than light in debate during the current crisis. The validity of one commonplace measure (REERs) widely used historically has been repeatedly questioned. In my opinion such questioning has been largely motivated by ideological and political motives in contrast to scientific ones. In fact the evidence is clear enough.The REER (or Relative price and cost indicators) aim to assess a countrys (or currency areas)price or cost competitiveness relative to its principal competitors in international markets.Changes in cost and price competitiveness depend not only on exchange rate movements butalso on cost and price trends. The specific REER for the Sustainable Development Indicatorsis deflated by nominal unit labour costs (total economy) against a panel of 36 countries (=EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, NewZealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculateREERs, reflecting not only competition in the home markets of the various competitors, butalso competition in export markets elsewhere. A rise in the index means a loss ofcompetitiveness. (Eurostat Definition)
Output & Productivity High output per worker and high wages are perfectly compatible. The road to achieve this win-win combination is through raising productivity, thus maintaining unit labour costs constant, or even reducing them.As can be seen from the accompanyingcharts, Germany achieved this combinationbetween 2000 and 2008, while Italy didn’t. In Italyproductivity stayed pretty much constant whileunit labour costs rose, meaning salaries rosewithout the accompanying productivity, while inGermany unit labour costs stayed constant whileproductivity rose. This also gived the lie to the“cheap German wages” argument, since if wageshadn’t risen then ULCs would have fallen, whichthey only did briefly between 2006 and 2008.
The problem in part is that value added is often a sectorial issue. For example agriculture and construction have historically been low value added and often high unit labour cost sectors, whereas petrochemicals or biotechnology are high value added but also often low ULC sectors, despite the fact that wages are higher.Naturally most societies would like to have a large proportion of high value added activities, anda comparatively small proportion of low value added ones. But this isn’t as straightforward as itseems, since the transition from agriculture to biotechnology doesn’t move along what we couldcall a smooth production function. Namely you can’t simply transfer workers from one section tothe other. It ain’t that easy. The large number of construction workers recently displaced in Spaincan’t simply move into machine tool manufacturing, for example. A countries ability to engage in what are high value activities at any moment in time depends onkey factors like the skill, education and experience levels of the workforce, and these changeonly slowly. Critically the distribution of these factors depends to some extent on the agestructure of the population.
But in part the level of unit labour costs depends on the level of international competitiveness, which in part depends how much of the economy is in the tradeable sector and how much in the non-tradeable part of the economy. By tradeable we mean in competition with other producers or service providers beyond the national frontier.The key mechanism assumed here is that the tradeable sector, being exposed to externalcompetition, by definition needs to be more competitive to survive.So a measure of a country’s lack of international competitiveness isn’t only that exportsare too small, it is also that imports are too big, which is another way of saying that thedomestic tradeable sector isn’t big enough. Normally this loss of competitiveness isassociated with a growing trade and current account deficit, which means the process ofnon productivity supported rising living standards can only continue as long as someexternal agent is willing to finance it. When confidence that the process is sustainablesubsides, people cease financing, and a crisis occurs. This is what happened to Italy in thesummer of 2011.
Export Dependency and International CompetitivenessBut now I would like to introduce an additional concept which is generally not acceptedin mainstream economic theory, the idea of export dependent economies. Basically theidea is that as populations age, demand for credit and with it the rate of increase indomestic demand wanes. As can be seen in the chart on the right below, householdconsumption in Italy surged in the 1990s, and the rate of growth in consumer demandwas quite rapid. The consumer boom was also linked to Italy’s last housing boom. Thenbetween 2000 and 2007 something changed, and the growth rate slowed. Any internallycoherent macro economic theory needs to be able to explain this change. Then followingthe global crisis household consumption slumped, recovered slightly and then slumpedagain.So if we go back briefly to the earlierchart on the composition of GDP, wecan perhaps formulate a new andbetter definition of internationalcompetitiveness, which would behaving an export sector which islarge enough and growingdynamically enough to produce GDPgrowth in an environment whereconsumer demand weakens aspopulations age.