Competitiveness: serious conceptual errors

José Luis Guajardo. Professor. Instituto de Empresa

18 February 2004

Few concepts in economy are so poorly interpreted and little known as “competitiveness”. The author provides us with a reality check.

Year after year, when introducing MBA students to basic macroeconomic concepts, I ask the following question: What is the most important thing an economy needs to prosper? Among the three most recurrent answers, “competitiveness” always crops up, like a karma that, if achieved, would lead economies into sustainable prosperity. The fact that these MBAs present varied professional profiles (doctors, economists, architects, lawyers) and all reach the same conclusion demonstrates the deep-rooted nature this supposition enjoys among the population.

My follow-up question is: What do we mean by competitiveness? And here the first doubts arise. The Spanish dictionary defines “competitiveness” as 1) Capacity for competing; and 2) Rivalry to achieve a goal.

This is how most people use the term in economics; as though countries were companies that compete in the international marketplace to sell their products and protect or increase their working population, fostering economic growth. Unfortunately, there is no greater misconception.

Why do so many well-educated people assume this supposition is valid, when the vast majority of economists do not share it? I have grouped the long list of answers into two types of conceptual errors.

Error Number One: confusing a country with a public corporation. Some years ago, in the Harvard Business Review , Professor Krugman used numerous examples to make the point that what one studies in an economics course is not much use when managing a company, and vice versa. For that reason, trying to extrapolate the situation of two companies competing in international markets to two countries is, to say the least, absurd.

It is true that, if a company in country X sells more abroad, it generates greater production and employment; but this is not necessarily true for the economy as a whole. For example, in an economy with nearly full employment, more exports can produce greater employment. But this can also lead to greater inflationary tensions, increased interest rates and higher unemployment in other sectors, such as construction, and one effect thus offsets the other. As a result, a company can be considered an open system, whereas the economy of a country is closed.

Something similar happens with the current account balance, because a surplus is wrongly interpreted as being positive and a deficit negative, as though it were a company’s trading result. It is understandable that no company wants a negative balance, but for a country, surplus does not necessarily have to be good, nor deficit necessarily bad. What’s more, if free to choose, according to classic theory, a deficit is preferable, because exports are no more than a means to the end of being able to acquire more imports. Other questions concern the size of the deficit or surplus, its structure, the way to finance it, or the current economic cycle. Thus, importing machinery and equipment is not the same as importing luxury cars; and, as these imports can mean improvement in productivity, a deficit can be highly positive.

Error Number Two: confusing Adam Smith with David Ricardo. A mercantilist view of the economy leads us to interpret international commerce as a zero-sum game, in which it is only beneficial for a country to trade if it can sell more than it buys. Adam Smith outlined the advantages of specialization in the economic production field and deduced that if one country is better at producing wine and another better at producing bread (i.e.; each has an absolute advantage in the production of one item), specialization and exchange between the two is mutually beneficial. David Ricardo’s contribution is even more significant.

It demonstrates that trade between two countries is beneficial even when one is more efficient in production of both bread and wine (i.e.; it has an absolute advantage in both goods). Thus, if each country specializes in that item whose relative productivity is greater, trading with the other will still be of interest, despite having a lesser absolute productivity. This is also true for that country with an absolute advantage in both goods.

One way of looking at this is shown in the attached table, originally published in The Economist , in which two economies, North and South, produce and consume bread and wine, and trade one item for the other at a certain ratio or rate of exchange. Each country has 100 workers and no other input is required for production, save labor. In the North, producing a bottle of wine requires one work unit, whereas in the South 0.9 bottles are produced per work unit. For bread, the rate is 1 to 1 in the North and 0.3 to 1 in the South.

If we analyze what each country produces and consumes before and after trading, we see that both benefit after trade, despite the fact that the North has an absolute advantage in production of both goods. This is possible thanks to wage differences between the two countries, which are determined on the basis of their respective productivity when it comes to producing the goods. Thus, the North will buy wine in the South for less than it would cost it to produce it itself, and the South will be paid more for each bottle it sells to the North than it would receive in its own country. In the end, both countries gain in revenue and in consumption capacity, clearly demonstrating the positive benefits of such trade.

Conclusion

In a world where what seems to be is sometimes more important than what actually is, it’s no wonder that the term “competitiveness” has been awarded an importance it lacks at macroeconomic level. Nor is it a coincidence that in over 1,200 pages of an economics manual such as Stiglitz’s, there is no mention of this concept. It doesn’t appear in the glossary, or have a chapter or section devoted to it. This is the case with the vast majority of serious books on economics.

Perhaps the aura of sophistication it appears to offer has turned it into a recurrent term for politicians, industrialists or analysts. Yet when all is said and done, it is no more than a serious conceptual error, whose gravest consequence is than it can divert attention, programs and budgets from the principal economic problems that affect us all.

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