International Competitiveness

What determines competitiveness? Competitiveness and comparative advantage in a truly global economy is a dynamic concept meaning that it can and does change over time. For a country, the following factors are important in determining the relative costs of production: 1. The quantity and quality of factors of production available 2. Investment in research & development which can drive innovation and invention 3. Fluctuations in the real exchange rate, which then affect the relative prices of exports and imports and cause changes in demand from domestic and overseas customers. 4. Import controls such as tariffs, export subsidies and quotas and other forms of protectionism these can be used to create an artificial comparative advantage for a country's domestic producers. 5. The non-price competitiveness of producers - covering factors such as the standard of product design and innovation, product reliability, quality of after-sales support. Comparative advantage is often a self-reinforcing process. Entrepreneurs in a country develop a new comparative advantage in a product either because they find ways of producing it more efficiently or they create a genuinely new product that finds a growing demand in home and international markets. Rising demand and output encourages the exploitation of economies of scale; higher profits can be reinvested in the business to fund further product development, marketing and a wider distribution network. Skilled labour is attracted into the industry and so on. The expansion of an industry leads to external economies of scale. Supply-side policies and competitiveness Supply-side policies are mainly micro-economic policies designed to make markets and industries operate more efficiently and thereby contribute to a faster rate of growth of real national output. Policies include: Competition policy including privatisation/nationalisation. Deregulation and regulation. Policies aimed at stimulating entrepreneurship and the expansion of smaller businesses Labour market reforms including tax and benefit changes, migration policy Trade policies including membership of the EU single market and WTO commitments Policies designed to increase spending on investment and research

Supply-side objectives The key supply-side concepts to focus on are incentives, enterprise, technology, mobility, flexibility and efficiency. 1. 2. Improve incentives for people to find work Increase labour and capital productivity

3. Increase the occupational and geographical mobility of labour to reduce unemployment 4. 5. 6. Increase capital investment and research and development spending by firms Promoting more competition and stimulate a faster pace of invention and innovation Provide a platform for sustained non-inflationary growth of an economy
UK Labour Productivity per Person Employed
Labour productivity relative to the EU average 114 114

113

113

112

112

111

111

EU27=100

110

110

109

109

108

108

107

107

106

106

105 95 96 97 98 99 00 01 02 03 04 05 06 07 08

105

Source: Reuters EcoWin

If supply-side policies are effective then an economy can Achieve a sustained improvement in the trade-off between inflation and unemployment Be more flexible in response to external demand and supply-side shocks Raise living standards through stronger long term economic growth Reduce unemployment by lowering the natural rate of unemployment and the NAIRU Improve competitiveness in global markets and achieve a stronger performance in international trade in goods and services

UKs productive capacity trend growth and the supply-side The economys productive capacity is determined by fundamental supply-side factors: 1. Changes in full-employment labour supply available for production

2. 3. 4.

Changes in the stock of capital affected by the level of gross capital investment Changes in the productivity of factor inputs Advances in technology and improvements in supply capacity arising from innovation

The OECD estimates that, following an improvement in the period 1993-2006, the UKs trend growth rate has declined to less than 2% - partly because of slump in investment and also reversal of migrant flows that have occurred during the recession. Research and innovation
UK Balance of Trade in Research Services
Annual balance, bn
3.0 3.0

2.5

2.5

2.0

2.0

GBP (billions)

1.5

1.5

1.0

1.0

0.5

0.5

0.0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

0.0

Source: Reuters EcoWin

Spending on research and development (R&D) in the UK has remained low as a % of GDP usually between 1.5 and 2% of national income. This research gap is a constraint on innovation and affects our global competitiveness. There are only two British firms in the top 50 global research spenders. Other countries including Finland, Germany and Israel devote higher share of GDP to research. The biggest barriers to innovation are risk aversion, uncertainty about ability to exploit research and make a profit, a lack of high-skilled workers and a lack of information on technology and markets. There is some evidence of higher R&D spending in the UK among smaller businesses in computing technology, biotechnology and nanotechnology. The top EU companies for research are Nokia, Volkswagen and Daimler. The top two UK firms are GlaxoSmithKline and AstraZeneca. The government has tried to boost R&D spending through tax credits but critics say that this policy has been ineffective in overcoming the barriers listed above. Much R&D spending by UK firms takes place overseas and is not counted in the figures. Despite the low percentage of GDP allocated to R&D spending, Britain has achieved a growing trade surplus in trade in research services, indicating a comparative advantage in this area.

billions

Gross Domestic Expenditure on R and D

Research and development spending expressed as a percentage of GDP 3.50 3.50

3.25

3.25

3.00

3.00

2.75

2.75

% of GDP

2.50

2.50

2.25

2.25

2.00

2.00

1.75

1.75

1.50 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

1.50

United Kingdom Germany

EU-25 Finland
Source: Reuters EcoWin

Supply side of the labour market focus on the UK labour market Before the onset of recession there were many positive trends for the UK labour market reflecting an improvement in the quantity and quality of the labour force A large rise in total employment (over 4m more in work between 1993 and 2007) and a steady rise in the percentage of the population of working age in some kind of job. An improvement in trade-off between unemployment & inflation (shown by a fall in the NAIRU from 8% to 5% of labour force) A strong flow of inward labour migration including a sizeable number of younger and highly skilled workers helping to reduce labour shortages. Sustained rise in labour productivity especially in manufacturing industries Fall in long term unemployment after the last recession of the early 1990s.

On the other hand long term weaknesses remain Skills gap many businesses remain concerned about weaknesses in basic literacy especially among school-leavers Workless households over 2 million people of working age who want work but are classified as economically inactive this figure is likely to rise further because of the recession Widening gap in wages higher relative poverty made worse by some long standing disincentives in the labour market, namely the existence of unemployment and poverty traps. Hard core unemployment over a quarter of the unemployed have been out of work for over a year, some for much longer. Many long term unemployed eventually leave the labour market (they become discouraged workers) and this is a permanent drain on Britains economic resources.

The record on productivity

Investment and Productivity in the UK Economy
Quarterly value of capital spending at constant 2003 prices, index of labour productivity 105.0 105.0
Output per worker employed, whole economy

102.5
2005=100 (millions)

102.5 100.0 97.5 95.0 92.5 90.0 87.5 65 Real value of capital spending, bn per quarter 60 55 50 45 40 35 30 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Source: Reuters EcoWin

100.0 97.5 95.0 92.5 90.0 87.5 65 60

(billions)

55 50 45 40 35 30

Productivity is a measure of efficiency of factor inputs. The UK has achieved a sustained rise in productivity although output per worker remains lower than many of our main global competitor nations. Labour productivity still lags the USA and Germany by more than 15% and there are signs that output per person employed will fall in 2009. One area of concern is productivity in the public sector which has tended to lag efficiency improvements in private sector businesses. Productivity has risen because of: Higher business capital investment see the chart above Impact of foreign direct investment e.g. where new production plants operating on a large scale drive efficiency higher Improvements in management and the expansion of productivity-related pay schemes Strong economic growth high demand means that capacity is used more fully

Manufacturing industry in the UK UK manufacturing industry is part of the secondary sector (together with construction). The sector has declined in relative size over the years but still accounts for around 13% of GDP. If we include the construction sector, industry as a whole contributes 20% of UK GDP. That said many service businesses rely on the manufacturing sector for their demand and profits. The multiplier effects arising from changes in manufacturing output can be quite high. Manufacturing is more volatile than services in part because of its exposure to fluctuations in demand & trade in the world economy - a high percentage of output is exported and therefore movements in the exchange rate and the world industrial cycle affect demand Recession hit UK manufacturing at the start of 2008 and the slump in production is illustrated by the chart below. By the summer of 2009 the index of manufacturing output was lower than it had been in 1993. Car manufacturing in particular has borne the brunt of the downturn with

billions

millions

many car plants being shut down on a temporary basis and shifts reduced. Production of new vehicles in the early months of 2009 was down by more than 50% compared to the same period in 2008. This has caused a negative demand shock for businesses in the vehicle supply chain and thousands of jobs have come under threat. In the March 2009 Budget the UK government introduced a car scrappage scheme designed to boost demand for new vehicles.
UK Manufacturing and Service Industry Output
Index of Production, 2002=100, Constant Prices, Seasonally Adjusted

110

110

100

Manufacturing

100

Index of output, 2002=100

90

90

80

80

70

Services

70

60

60

50 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

50

Source: Reuters EcoWin

British industry faces many challenges: Short term 1. 2. 3. 4. Depressed domestic demand e.g. for vehicles and household appliances Difficulties in raising finance / credit Stiff competition from overseas Weak export markets as global trade shrinks

Medium term: 1. Finding sufficient skilled workers (e.g. a persistent shortage of scientists and skilled engineers) 2. Emerging market countries will develop stronger competitive advantages in higher value-added and high-knowledge industries 3. Threat of further rises in fuel and raw material prices which will squeeze profits UK manufacturing needs to build on the areas in which it does have a competitive advantage for example in high-value engineering, steel production, aerospace and related industries. There are also huge opportunities for developing a comparative advantage in manufacturing processes linked to low carbon products and other green businesses. Suggestions for further reading on supply side policies
Blog articles on supply side policies (Tutor2u)

Infrastructures value to economic growth (BBC news, March 2009) Public sector productivity falls (BBC news, June 2009)