Friday 29 July 2011

You shall foster competitiveness

Euro area leaders face demanding tasks. The high level task is the requisite to concur on the analytical model of the currency area. The more practical task is the need to dampen the imbalances generated by relative cost misalignments of the participating countries. To adress the latter, leaders can choose from a collection of solutions ordered by the degree of economic and financial integration that individual members wish to pursue. Unfortunately the identification of what member states wish cannot be defered to the next european election (2014). As of today, european leaders have agreed or announced measures (my reading could be biased) to:

1)Improve financial markets and banks stability mainly through the EFSF

2)Strenghten real convergence through the Euro Plus Pact adopted last March

Regarding 1), leaders should enhance the quest of stability with a movement towards further financial and banking integration. I will not engage this argument but point the interested reader to this lucid analysis.

Regarding 2), leaders should be more ambitious on the instruments and instutions needed to achieve the desired level of policy coordination.

Let me change scale somewhat abruptly, and focus on the first policy commitment of the Euro Plus Pact, namely “to foster competitiveness”. The text agreed by the European head of states says that the assessment of competitiveness adjustment needs will be based on “unit labour costs (ULC) for the economy as a whole and for each major sector.” A precise identification of competitiveness as ULC is useful and necessary as it permits to adopt concrete policy measures.

The competitiveness of an economy is a multidimensional idea and economists have constructed several different indices to measure it. This multidimensionality necessarily leads the different indexes to exhibit different patterns. Some commentators interpret negatively the observed difference in the dynamics of these indexes. Their argument is that, if different measures of competitiveness exhibit different patterns, they must lead to different conclusions. Therefore these indexes of competitiveness, such as ULC, are flawed and cannot provide guidance to the unidimensional objective of promoting export growth. I will not dispute that measures of Real Effective Exchange Rate (REER) based on different deflators and/or weights exhibit “unsatisfactory” behavior. However, I believe, the above reasoning on the heterogeneous behavior of the indexes, does not consider the dimensionality of the idea of competitiveness.

I am more concerned by a subset of commentators, who build on the possibly contradictory pattern of the different REER, and shift the focus from relative costs misalignment to composition issues. In simpler words they argue that if Portugal has a trade deficit, it is not because its relative costs are high but because it produces the wrong goods. I bypass the economics of this argument, but I am curious to know what type of good is not produced in Portugal (exclude military submarines). Consider the following thought experiment. Assume Portugal was part of an exchange rate mechanism instead of a currency area. Would we expect a nominal devaluation to improve the trade balance? If the answer is yes, I would defend that trade deficits have more to do with cost misalignment than type of products. (Even after acknowledging the “this time is different” echo in light of China & co access to the WTO.)

The Euro plus pact correctly focuses on intra-european competitiveness. Eurozone members are obviously free to improve their trade balances vis-a-vis the rest of the World. However they must consider that their trade balances respond much more to change in relative costs and external demand within the currency area (“long-term price elasticities for intra-euro area exports appear to be at least double those for extra-euro area exports” ). I could not find estimates of Portuguese elasticites for intra-euro and extra-euro exports. It would be useful to have them.

Let me end with a digression. During the last two years, commentators have changed the designation of euro members that could not anymore access financial markets from “southern” to “peripheral”. I find this labebling both imprecise and misleading. We should relabel the so called peripheral countries as current account deficit countries and the so-called core countries as current account surpluses countries.

1 comment:

  1. Your post raises several important issues that remain unstudied in Portuguese Economy or poorly investigated. However, one of the questions regarding trade deficit origins can be clearly answered from a “real economy” stand point.
    Portuguese trade deficit is due to consumption models based on goods, which are not produced in Portugal. This is a long historical fact, then a systemic or structural error.
    We are not able to produce much of nowadays is considered a regular or average European life and economic standard. LED and Plasma televisions, Cell phones, I Pod’s and the rest of I Gadgets family, automobiles, lorries, ships, planes, satellite communications, electricity and crude. Not to mention the incapacity of domestic providing for a majority of the supermarket chains with fresh vegetables, like potatoes or apples, or the dreary import of a fishery.
    On the other hand, installed production capacity is obsolete for the international markets. Industry and Services success cases lack of replicability due to inadequate funding, training or incapacity of Portuguese politics help to overcome economic and bureaucratic barriers in foreign markets.
    Moreover, Portuguese government’s inability to help and endorse entrepreneurs abroad explains much of the foreign endeavors disaster.
    To enhance Portuguese competitiveness, the government must assure two sorts of conditions for companies and entrepreneurs. It must reduce infinite context costs related to rates and fees, certificates and authorizations. Furthermore, government cannot forget effective reduction of company’s social security contributions. On another hand, it must create, by its own funding needs reduction, the necessary conditions to let entrepreneurs access to adequate funding, to finance their projects and create jobs.
    The challenge it isn’t as hard as it looks if one attend to the central issues, and forgetting personnel interests in the benefit of the whole, although it is a complex and arduous job.