OCR F585 June 2011: Competitiveness

One important aspect of the OCR F585 stimulus materials for June 2011 is the economics of competitiveness within the single currency zone - the Euro Area. A conventional view is that some of Europe’s peripheral countries (notably the PIIGS) have become uncompetitive because they have allowed their producer prices, consumer prices and relative unit labour costs to rise. This - in the absence of a compensating exchange rate depreciation - has made their manufacturing and service industries relatively more expensive leading to a deterioration in trade balances, slower growth and stagnating living standards.

The OCR stimulus material does provide some evidence on producer prices and relative unit labour costs - and on a simple measure of labour cost per unit it does appear that countries such as Spain and Greece have lost ground to countries such as Germany whose unit labour costs have actually fallen in recent years.

But a key evaluation point is that competitiveness is not just about cost!

What also matters are the types of products that a country specialises in and can they export to fellow EU and non-EU nations. Can economies such as Spain and Greece and Italy any longer compete on cost and price in low-value added manufacturing products with the likes of China?

Would they be better served in the long run by attempting to move up the value chain and head in the direction of Germany whose heavy emphasis on high-value industrial products underpinned by strong research and innovation gives them a competitive edge in world markets without them having to worry too much about the external value of the Euro?

One can become more competitive by lowering wage costs and raising productivity - the former imposes a deep cost on people in work and can easily backfire because of the consequences for consumption and aggregate demand. Or one can take an alternative pathway and encourage investment in industries with strong growth potential with a high income elasticity of demand in the world economy.

What goes into the export basket can matter as much as how much it costs to make and to buy.