04 February 2011

Countries Do Compete

Ireland for example has a low rate of corporation tax in order to attract firms to set up there. Countries and regions compete for inward investment.

Imagine a Japanese car company wanted to set up a new factory to produce luxury cars for the European market. It choice of location might come down to Belgium or Slovakia. Both countries would court the Japanese investor. One of them wins and X billion Yen are invested in the lucky nation.

That is not the end of the story. Net trade is equal to the difference between domestic savings and investment:
X-M = S-I
(exports minus imports = savings minus investment)

So all else being equal, the winning country would find its trade balance falling by X billion Yen. In other words the more successful a country is in attracting inward investment, the bigger its current account deficit gets.

That is one reason why the current account does not tell you whether a country is economically successful or not. There are many reasons why the current account might be in surplus or in deficit. Conversely, being competitive in export markets need not equate to economic success.

The idea for this post arose from a discussion I had while on my quest for enlightenment on the issue of competitiveness

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