28 October 2010

A Picture Tells Another Story

This chart appeared in The Economist last week to show how strongly Germany has emerged from the recession.

It is clear that GDP growth in Germany has recovered ahead of the 5 other countries. Looking at the early part of the chart tells another story. In 2002 and 2003 Spain, Ireland and Greece were growing much faster than Germany, France and Italy. While Germany struggled to get growth up to 2%, the three peripheral states were touching as much as 6%.

Think about interest rates. Germany, France and Italy needed low rates to stimulate their economies. Ireland and Spain need higher rates to stop their rapid growth leading to inflation. In fact, inflation in Spain and Ireland was around 4% at the time and house price inflation even higher.

All six countries are in the Euro zone and so had the same interest rate - one more attunued to the needs of the three larger economies than the smaller ones.

Higher inflation, makes countries less "competitive". (Yes, I am still on my quest.) If costs have risen then the price of exports are higher and the price of imports lower; another meaning of the word competitivness.

So when this week's EU summit talks about the competitiveness of peripheral countries in the Euro zone, there is an explanation in terms of the problem of controling inflation when monetary policy is not available to help.

15 October 2010

Currency Wars and Competitiveness

Today's papers are full of talk of currency wars. The US dollar has fallen. China is accused of holding down the value of the Yuan. Brazil is using taxes to limit flows of hot money pushing up the value of the Real.


It is all about competitiveness and so we enter another stage on my quest to understand what that means.

If countries can increase their competitiveness by lowering the value of the exchange rate then we are talking about increasing exports and reducing imports. There is a tendency to report countries with a trade surplus, or more broadly a current account surplus, as competitive.

The question is should a lower exchange rate be an aim of economic policy? Should we look to become more competitive by reducing the exchange rate?

The obvious objection is that everyone can not become more competitive at the same time. If everyone tried to devalue 5% then their exchange rates would stay the same.

Globally the sum of all exports equals the sum of all imports. Every trade has an importer and an exporter. Increasing exports in one country increases imports elsewhere. This is why competitive devaluation is often called a beggar-my-neighbour policy.

The danger is that this turns into protectionism, reducing global trade and the benefits which that brings. Which happens to be one of the reasons why Krugman, in the article I quoted before, calls competitiveness a dangerous obsession.

What is happening right now is that there is not enough demand and so countries try to add to demand through increasing net exports, which amounts to taking demand away from other countries. What the world really needs is an increase in demand overall.

10 October 2010

Is Competitiveness Europe's Problem?

I have embarked upon a quest. I think this blog might be a good way of documenting my progress.
A few months ago, doing my day job, I read a very dull report on EU regional policy. Every page of this document talked of the importance of "competitiveness". The economy of the EU needs to be more competitive. Europe's member states need to be competitive. Europe's regions should be more ...
The word was repeated so often I began to wonder what it means.
I have some economics textbooks on my shelf so that is where I looked first. Competitiveness is not in the index of my macro textbook (Mankiw, 5th edition) nor of the micro (Estrin and Laidler), nor of  a couple of development economics textbooks, nor one on international political economy.
A bit more research turned up an article by Paul Krugman from 1994 where he lays into the new fashion for discussing economies in terms of competitiveness.
"So lets start telling the truth: competitiveness is a meaningless word when applied to national economies.And the obsession with competitiveness is both wrong and dangerous."
And yet, the word is found in nearly all policy documents I read on European economic policy. Sixteen years on, the obsession continues.
My quest then is to understand what national competitiveness is. Can it be measured? Is it dangerous, as Krugman says? Is Europe's economic problem a lack of competitiveness or is it a misguided search for the chimera of competitiveness?