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What Measures National Competitiveness: An Economic Theory

Updated: May 1, 2023

The Theory

Defining national competitive advantage is a controversial issue among economists, differentiating between national and industry level competitiveness creates conflicting theories, however, productivity is a parallel component amongst theories that propel national growth, living standards and their competitiveness in international markets. Ricardo's analysis of comparative advantages is at the foundation of modern approaches as it outlines factors of production relative to other countries and measures those opportunity costs. Countries that have comparative advantages can gain from trade in many ways as comparative advantages become competitive advantages in the long run. Porter's 1990 diamond framework is somewhat conflicting with classical theory. It focuses on industry-level prosperity, stating that a nation's productivity is reliant upon firm's ability to innovate, advancing them in global markets; which for certain industries can be the case. Classical models determine competitiveness based on labour costs, exchange rates and economies of scale, whereas Porter's theory emphasises the importance of national values, economic structure and culture. Measuring competitiveness at industry levels is less complex but incomparable to national competitiveness. Krugman criticises new theory for attempting to analyse national competitiveness, stating that fixating on the matter is a 'dangerous obsession' and can result in poor policy choices. The macroeconomic objectives of nations typically aim to increase the living standards of citizens whilst maintain a sustainable level of domestic growth; using welfare as a measure of competitiveness. Whereas at industry level firms aim to maximise profits; which makes for an easier relative comparison. Furthermore, in perfectly competitive markets, firms are competing for the same consumers meaning that one firm's gains are at the expense of another firm. With countries, however, this is not the case as Krugman outlines. Economies can benefit from prosperity among other nations; the success of one economy does not necessarily come at the expense of another. Although as switching focus to domestic growth and productivity, as emphasised by Porter and Krugman, takes reliance off imports and as outlined by beggar-thy-neighbour policy, ultimately contradicting Krugman's statement that 'International trade is not a zero-sum game'. Countries exploiting their comparative advantages can benefit from trading with each other where both economies can gain eventually leading to increasing welfare simultaneously. The incomparable elements of national competitiveness are emphasised further if we consider non-prosperous firms and countries. Companies running into financial distress eventually go bankrupt as losses are unsustainable; however, for countries, this is simply not the case. Increasing trade deficits eventually dampens domestic growth, but countries can't go bankrupt, so to speak. The framework of Porters model allows analysis at the firm, industry and nation levels. He uses certain determinants to explain national competitive advantages; however, emphasises specific dynamic elements as his framework states increasing country living standards is reliant upon firm's capacity to innovate.

Porters Diamond Model

Source; World Economic Forum


Factor and demand conditions – each country is unique regarding the environment, population, culture and politics, therefore, factor inputs such as human capital and natural resources, however domestic demand is essential to force innovation and therefore growth. Firm Strategy, Structure and Rivalry – much like domestic demand, domestic rivalry also encourages firms to constantly innovate, creating unique products or services, which as a result, propels them into the international marketplace. Related and Supporting Industries –without a strong support network which is typically developed through some form of FDI, firms are less likely to excel as they can't experience the same benefits. Close relations with supply and distribution channels allows for a more efficient use of firm's resources and results in streamlined performance, improved quality and maximised profits. Limitations of The Diamond Although Porter gives an extensive review, it should be acknowledged that the role of government is one crucial factor that is somewhat overlooked. Government policies respond to aggregates within the economy which are influenced by demand conditions; so, considering demand without government interference seems slightly counter-intuitive. Also, both classical theory and Porter’s determinants carry certain flaws, which perhaps can be considered using a real-life example. Take Venezuela, a country rich in natural resources (oil, gold) however suffered from a catastrophic economic collapse over the past decade mainly due to hyperinflation and political unsettlement. Their natural resources had no impact on productivity, and due to depreciation in their currency, Venezuela rapidly became a highly uncompetitive nation. The purchasing power of the Bolivar came under pressure which, as a result, deteriorated the nation's trade balance. In such instances, increasing trade deficits in nations with vast natural resources can well outweigh any attempt at domestic growth during a crisis; this is because, to be categorised as a 'factor-driven economy' according to the global competitiveness index (CGI), the country's exports must account to at least 70% of mineral resources. The Analytical Framework The CGI combines macro and microeconomic data into a single index which measures national competitiveness. It categorises nations by stage of economic development and the graph below illustrated key elements, otherwise known as pillars, needed to encourage growth.

The 12 Pillars of Global Competitiveness Index

Source: World Economic Forum

Reverting to the Venezuela example, the CGI shows that being abundant in natural resources, basic requirements such as institutional influence, infrastructure, macroeconomic stability and education are essential; unsurprisingly they ranked amongst the worst of all basic factors by 2019. It should be acknowledged that the difficulty underlying CGI, Porter's theory and classical views is that determining competitiveness in comparison to productivity or trade omits a crucial factor of national welfare; wealth inequality. How can it be that such developed nations with high index rankings still experience extreme concentrations of wealth? For example; millions of middle-class Americans don't qualify for state-funded healthcare but also can't afford insurance; somewhat attributable to stagnant wages but rising prices. However, USA ranks 2nd on the 2019 CGI; it raises questions around who reaps the benefits of innovation and domestic growth and does the benchmark of living standard paint an accurate picture? Even the classical theory of overall welfare fails to expand on this issue as does much of the empirical evidence. Final Thoughts Such a complex dynamic topic restricts the ability to conclude, hence why the debate still prevails. Regardless of the theory analysed, discrepancies arise when attempting to define national competitiveness in one single take. What makes a competitive country in real terms? It should be acknowledged that overall welfare, education, healthcare and even life expectancy are comparable factors globally which the CGI ranks accordingly. As such, public policy plays a vital role in determining living standards, and as discussed with Venezuela, the political motives of government ultimately dictate economic competitiveness. In such extreme cases, classic theory and Porter both fail to explain the dynamics where Government leadership ultimately dictates prosperity.


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