summaries

OXFORD REVÍEWOF ECONOMIC POLICY, VOL. 12. NO. З

üncfer licence

I. INTRODUCTION

The ∞ncept of international ιpetitiveness, as

look at whether it matters fbracounlry and whetherbalance) performance of different countries. indi٠

word when applied to national economies. And the and the term seems to mean different things to

© 1996 OXFORD UNIVERSITY PRESS AND THE OXFORD REVIEW OF ECONOMIC POLICY LIMITED ]

t Chris Allsopp. Andrew Glyn,Tim Jenkinson, and Vijay Joshi provided many helpful suggestions, bütcannoibeheíd responsible sor anything written here

THE ASSESSMENT: INTERNATIONAL COMPETITIVENESS

glative price or cost indices regularly published by the IMF and the OECD、or the absolute measures

casrs are produced showing changes in, or levek insistence on it is as dangerous as argued by o£ various countries' competitiveness (e.g. the Krugman. Sections IV and V then discuss the short*

ANDREABOLTHO Maralen College, University as 5ford1

obsession wiŵ 8mpetitiveness is both wrong and dangoous'(Krugman, 1994,p.^),a^sition Krugman forcefully neaffîi in his contribution to this issue of

run interactions between competitiveness and ex- lemai balance, while section VI tackles the longer-

produced by organizations such as the Geneva runonesbetweencompetitivenessandproductivity World Economic Forum and the Uusanne Institute growth.Theconclusions look briesly at someimpli- for Management Development. Governments of： cations for policy. ten instigate research on the matter as, for instance, in the case of the 1993 ขร Competitiveness Policy Council or the 1995 EU Competitiveness Advisory IL WHAT IS COMPETITIVENESS ? Group. Yet, it has recently been argued by Paul Krugman that，competitiveness is a meaningless There are no agreed desin itions of competitiveness

applied to national economies, is a popular one. the Oxford Review of Economic Policy. Politicians, businessmen> and economists alike, re٠ serto it inday#to-day discussion when lookingatthe The next two sections explore this issue: they external (export, impon, market share, or trade examine the problem of defining 8mpetitiveness,

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DteVïEVVOF ECONOMIC POUCY,VOL.12.NO∙3*》■¢。 י

domestic inSation, as was done in a number ofrate. In some cases the arguments are not about a

run 'fundamentals', as was clearly the case for thedebate has often been confused. At the risk of over-

si٠n presented in Corden (1994).

(i) Definition

паї and exteπιd balance in the short run and of as can lead to permanent losses in markets and, more rapid agrowtħ of living Ềdards as possible in the importantly, to high unemployment which, in the

European context at least, can then seed on itself.long n1n٠ Intemal balance is commonly defined as

and (broadly defíned) external balans.

Thus, a lack of competitiveness would mean that a

used interchangeably. of productivity. Should such unfavourable trends in

2

petitivsess in this context could be defined as the with international competitiveness is largely irrei- level ٠fthe real exchange rate wh ich, in conjunction evant in this context.3 It is not totally irrelevant, withappгopriatedoлוesti¢poli٠iesיensured internal however. A potential link can be established—the

simplification> the following will try toprovideιe UK in 1979-80, for the USA between, say, 1983 definitions |which are broadlym line with thediscus- and 1985, and for Japan in 199Í5. Surely, few

diffZrentpeople—somemay Issacountry,s low Reasons why the real exchange rate might be 'too costs or the level of its exchange rate, others a high' can easily be found. Governments 8uld fbl- counuy'stechnologicalleadershiporevenitsgrgwth low inappropriate pegging policies inorderto lower

lofaf¥airs,butabtl>ehavioun with the ideaos counưies in the European Monetary System (EMS) cœnpetitivenessbeingaιiatedwithnva!σ.Given between 1987 and 1992، Altematively, markets such different Staft1ngf×)ints^ it is inevitablethatthe could push exchange rates away from the longer-

most for achievinghigher incomes are the domestic forces that propel productivity growth, a concern

claim that a country lacked competitiveness could mean that the domestic growth of peductivity was associated with unfavourable trends in the insme

8untry, at ftill employment, was mnning a persist- elasticities of demand for the country's exports and ent(andunwclcome)current~accountdeficitwhich imports. Suchadevelopment would, in tum| require would in due courserequire adjustment, usually via continuous depreciation in order to ensure extemal a mixture of deflation and depreciation. In other equilibrium. Continuous depreciation, however, words| thecountrywouldsufser from an Ínappr٠prí٠ raisesonedífïïculty and one potential problem—it ís ate level of the real exchange rate (Corden, 1994). likely to become progressiveJy less effective, as its It is a matter of semantics whether one wkhes to impacton domestic inHation is increasingly antici- call such a state of affairs an exchange rate or a pated and, even if successful, it usually leads to competitiveness problem. Strictly speaking it is the terms-of-trade deteriorations which reduce the fo∣r,yetthe word competitiveness is commonly growth oflivingstandardsforany given growth rate

The aims of macroeconomic policy are usually misalignments can be significant-in panicular, a d^nt>edastħeachievement of simultaneous inter। pglonged period of exchange-rate overvaluation

even desirable> provided that they are also sustain! able). The desirable degree of international com-

would question the widespread view that Britainand the USA in the early 1980s, or Italy in the early 1990s| suffered from low competitiveness on world markets.* The macroeconomic costs of such

tbekjwestpossiblemgofunemploymentsnsistent Policy concern with 8mpetitiveness in such cir- with an acceptable rate of inflation (for simplicity cumstances would seem to be clearly warranted, called ĥin employment, and external balance as some desirable level of the current account (for Tumingtothe1onger∣runaimofnsmglivingstand, simplicitye<]u4tedwtthcntiaccounte٩uilibrium> ards, the degree to which this can be achieved is a though in today's w51d prolonged periods of sur- fhnctionofEbourproductivityggwth, adjusted fbr pluses ٠r deficits are ٠ ٠ f course, quite common^d changes in the terms of trade. Since what matters

Strictly speaking, of course, it was the írađable sectors of those countries which were negatively affected, and not the wholeי economy。Thus, in the case of the USA. it could be argued that the rise in the dollar's real exchange rate helped dampen ι∩ilut1on inaboomingeconomy. In Britain and Italy, however, there islinle doubt thai *lack orcompetitivene$Cvascontrib1uing[ø recession or low overall growth. ιa demonstration efsecιs. leads to the adoption of better ١ .Unless it raises awareness of other countries' successful policies andי

practices at home.

А. Boltho

the policy implication or prescription that Ŵe struc∣ relEbleandtimelymeasurementsofchangesinthe ture of specialization should be changed.

A possible definition of international compeHtive- hence provide onlyaveryRÍnđicationof changes ness in this longer-run context could be the highest inacountry's intemational competitiveness. Rela-

Relative cost indicators overcome many of these

tions of Jan Fage⅛g and John Llewellyn to this eliminate cyclical fluctuations in labourproductiv- issue.

(1i) Measurement

Competitiveness in the short ณท has here been depreciations), can now be associated with either equated with the value of the real exchange rate. declines in tradable prices or with increases in Measuring such a value in pmctice is bght with proStability,orwithamixtureofthetwo,depending

^dable to tradable prices(see, e.g.| Corden, 1994), the index ignores costs other than labour but it with a rise in the ratio denoting appreciation. This can be argued that changes in both raw material

small open economies fbr which the terms of trade kets. (For a fbller discussion of the merits and

rate(particularlyin the industrial ized world).

٠Tbe indicators that are most frequently used to sF1fic problems (other than those associated with pgχy the real exchange rate in applied work are the measurement of all national accounting relativeprice and/or cost indices expressed in some magnitudes) since the data on various countries'

performance in this area are eadily available.8mmon currency. Among the most readily avail-

3

difficulties. The theoretical literature oñen defines the reaỉ exchange rate as the domestic ratio of non-

Variantsofit can½fbund in an earlier report by the difficulties. Theonethat is most frequently used in US Competitiveness Policy Council, in EU or UK empirical work is an index of relative unit labour

the terms of trade be signífícant, lack of competi- tiveness in this longer-run sense would, in turn, carry

on what strategies fkms fbllow and on the nature of the markets in which they compete. It is true that

be virtually synonymous with trend productivity growth. Measurement in this instance raises no

costof!≡ving. Such indices, however, includea large number of non-traded goods and services, and

able are indices of relative consumer prices| thanks to the existence in most countries of reasonably

8sts in the manufacturing setor, defined as labour costsdividฝ byoutput(sometimes'normalized'to

White Papers, in the work of the Geneva World EconomicFoEm,or,fbrthatmatter,in the contribu-

definition, however, is not problem-ftee. Thus, by and capital costs will be more similar across c٥un٠ lumping together exports and imports into one cat♦ tries than changes in wages, given capital mobility egory of tradabks, it is really only appropriate fbr andtheexistenceofworl&wide commodity mar-

poβsiblegrowthofρroducHvibthatwas8mpatible tive export (or impoN) price indices are clearly ỂextÉequỉlỉbrii. An alternative,ฟ၊٠^6^ prefierable,'sincetheycoveronlytradableproducts. version bas recently been provided by the OECD: They sufRer,however,fiom someotherdrawbacks. 8mpetitivenessis'thedegreetowhich[acountιy] One problem is that they ignore potential trade, can,ueder£reeand^irmarketconditions,produce Anotheristha£byfbcu$ingonrelativepricechanges, goods and services which meet the test of interna। they are only really relevant to markets in differen- tionalmadtets, while sim^taneously maintaining tiated ρ^ucts. In pe⅛tly∞mpetitive (as well as and exp∞ding the real incomes of its рторіе over insomeoligopolistk)markets,pricesmaybegiven the longar t٠rm٠ (OECD, ]992, p. 237). Such a andchangesincompetitivenesswillmanifestthem- definition, whose origins apparently go back to a selvesviachanges in profitability. ιmitwe set up by President Reagan (Tyson, 1992), seems to have received wide acceptance.

ity), and expressed inacommon currency.Themain advantage of such an index is that sudden changes in smpetitiveness (whether these take the form of falls in wages, rises in productivity, or nominal

are set by the world market. Few industrialized demerits of various such indigs« see Bank of countries, otherthan perhaps Luxembourg, would England(1982).) seem to fît the bill. More importantly, there are haiMly any data regularly available on this basis. In the longer run, the expectation is that the real Hence, the concept is virtually ignored in empirical exchange mte will convergeto its equilibrium value, and policy-related discussions of the real exchange Competitiveness, as was argued above, would now

tu. PROTECTIONIST DANGERS

Krugman's main, objection to the concept of com- More importantly, at least from a European per-

and hence the level of employment. Beggar٠thy٠

rate would have to appreciate, suggesting the pres-

etc.

In practice, however, things are not always as

cies designed to promote their own firms at the rounded by greatuncertainty֊—estimatesofequilib-

4

expense of other соипІгіе5١рЫисег5—the danger highlighted by Krugman.

Most countries in the world, however, remain pre- protectionist pressures which are likely gsurf⅛κe in occup⅜edwitħ(thougħnotnecessarilyobsessedby) those countries hit by overvalued exchange rates.$ the value of their exchange rate and their external economic perfomance. Sometimes ihis concern

depreciations/appreciations firstand to their inevita∙ ble reversals later, and should also defuse the

but f⅛w would doubt that the removal of trade enee of a zero>sum game. Yet, surely, the world bar٠٠٠ne essential i։®edient.”ntematisal should be better off in the longer run if exchange Cγ0⅛<⅛iiti0n∣ not the rivalry 0^นก№1«รพ٠।ฟฝ by mtes moved away from unsustainable levels. This their٠^tit{٧eness,।n।d0thisdismantlementp٠s٠ would bwerthecostofexpensivetwcxway trips of sible, tbroygh oι⅝anizationssuch as the GATT, the resources between the non-tradable and the trad- OEEC, the European Common Market, NAFTA, able sectors of economies subject to excessive

can, indeed, lead to wrong policies (as, fbr that simple. Thepolicyoftimely depreciation advocated matter, can concern with inflation, unemployment, by the textbook assumes that the authorities know budget deficits, etc.). Thus, govemments could try the value of the exchange rate which will generate to boost national competitiveness by embracing external balance and that the foreign-exchange protectionism, or by following strategic trade ρoii> markets win comply. Yet, the Rf⅛t issue is sur-

witfl e٠٠l।^r, despitệ thflpoŖular^rceptiôn that 8mpetitiveness(e.g. by cutting nominal wages or tħ⅛d(λWi⅛successsoκ⅛eθ∏nw1tħmapaιticu∙ by engineering a depreciation of the currency) larmtt4etisalmostbit⅜aMsociatedwitħ losses would raise the production of domestic tradables

According to conventional measurements, the static gains from free trade (and the static losses from protectionism) are veryי small, but such estimates ignore the far more important dynamic effects which an increased degree of competition will have on ٠x- effîciency٠(see. e.g. Owen, 1983).

That was clearly the view taken by the participants in the 1985 Plaza attempt at bringing down the dollar Both Japan and ح Germany feared that continuing dollar overvaluation and mounting US external deficits could destabilize the world economy and. in particular| strengthen protectionist Forces in America.

,Γheaf∣Qrtιent 100bcompelling. That tree interna। Inprinciple,atbt٠theresh٠uld١)en٥such dangers ।10၊м1Нві&Л0Іа?еп>।8шпвате is amply demon- ifcountries^to improve their competitiveness by د»၊«لهخص growing prosperity ofthe last 50years bringing down aclearly overvalued excحge rate,

in tf∣Q OEĊ0 area. Numerous fbnces were, of Admittedly, in such a case some other exchange cotiτs4∣atW(M⅞ςm⅛nsuringthιssucιfuIoutιe, rate would have to appreciate, suggesting the pres-

pedtiv^ness is that it involves the idea of inter- countiý rivalry. This idea is misleading, he argues, spective,isafhcheranddiffbrentdanger∙lnawcr∣d sinceΙ⅛⅛, unlike companies, donot∞m^te of less than iull employment, improving national

for.« й firm, this is justι!not so for countries mt⅛iianabde isaposh∣ve∣sum game and suc٠ neighbrpoliciesofthis kind,however,invite retali֊ ce^^foroįnte^ęuntry usually translates into success ation and their ultimate result is likely to be not a for it⅛ part^erç as well, because they now benefit zero- but a negative-sum game. Trying to reduce Írom die âvaiitabílíty of new and better products, nominal wages in every country wouldlead tohigher iro∣n r∣⅛⅛er ⅛iarke½ abroad, and/or from more unemploymentaliround. Withoutanyone١sc〇mpeti٠ 痴&٠曲凍岁 tenns of gdc. Looking at couiMes as tivenesshaving improved, whiletit-for-tatdeprecia- p〇a٥n6H*iva1si3H٠u8misl@adihg. Indeed, it could tiens would similarly leave real exchange rates ds٠te<٠gę٠ b⅝cadse∣by stressing Ẁe ideaos unchanged, but in this case result in generalized c٠٠lfct٠j<٠n strengthens protectionist pressures inflation as a consequence of easier monetary poli- athfotf∣⅛(kn⅛m∞, 1994). cies.

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achieved a good deal. At the world level its resultsnum exchange rates can vary by very large mar- gins.6 As for the behaviour of markets, this is well are patchier, if only because the USA frequently

succumbs to the temptation of ‘shooting from thekn٠١vntobeuf।predbble.Over٠rødunder٠shoot֊

ism which stilloccurs,t>oth intheUSAand in the resipower parity value over the bnger run is patchy at

coggWie& and that *count<o*>measurest should be widespread preoccupation with the external bal٠ taken.7 Sometimes one can blame markets for anceandwithcompetitiveness,whichcanbefbund

at almost all times and in almost all latitudes, ispushing exchange rates away ft٠om the fimdamen- taJs. Sometimes, however, govemments may also unlikely to be just a function of mercantilist begui⅝y⅜ misperceptions.

the terms of Hade, as long as such policies do not Such concerns were particularly acute in the worid

Cleariy|sub-optimal outcomes arealways possible. The world, however, has changed. Exchange rates International cooperation can tryto limit their scope are now, in principle at least, fully flexible and, sor and, within the European 8ntext, has undoubtedly the advanced gantries, access to wor■ capital

5

rates is nowhere near having reached such a con- sensus.

instance, for the UKeconomy from the early 1950s to 1967).

F<4idiation. Large countries(e.g> the USA) which prevailed underthe Bretton Woods system. -՞to benefit more from the latter policy (they If exchange rates are fixed, foreign curτency re سا$

cdenιed with the welfare of their own citizens rather than with world welf⅛τe, the use of the

petitiveness would then allow the achievement of external equilibrium and leave govemments Gee to

policy (the impact of their action is too small to be internationa{com∣)etitivenessinsuch circumstances perceptible fbr most other countries). Fortunately, would mpidly sorcegovemments to impose resiric- international cgperation through the GATT has tivepolicies,thusreducinggrowthandraisingunem- greatly reduced the use of unilateral trade policies, pbyment. A competitiveness problem can dearly Unfbstw^ely,intemationalcoopcmtiononexchange exist (and this was often said to be the case, sor

enjoy some monopoly power in international №de end need not ifear retaliation from smaller econo- mi0s); small countries can benefit from the foιmer

bestQsard, 1995). Hẹnce٠٢ifadepre٠iation occurs, of the world, is really prompted by a concem (or it 8n M⅛iiy give rise to, accusations that it was obsession) with competitiveness rather than by the *excessive*, that it did į٠lj٠bs away, from other pressures of setoral interest groups. Surely, the

serves arelimited, and capital mobility is restricted, obvious external constraints face countries which run persEent current-account deficits. Lack of

ing of currencies is common and the evidence fbr hiρ', be this on trade or on exchange-rate policy. It ihe return of exchange rates to some purchasing 1sdoubtful, however, whetherthe limited protection-

To take Just one example for 1990. the OECD put the purchasing power parity (PPP) value of the dollar vis-à-vis the خ E>eutschmaå and the yen at 2.09 and 195 respective।>| while Williιson*s estimates osthe *sondιental equilibrium exchange rate' gave values for the first quarter of thal year of 1.41 and | I4 (Williamson, 1994). as against market rates at the time of | .69 and 148. Yoshitomi, in this issue, estimates Japan's 1990 PPP for tradables al 122 yen per dollar. This need not always be so. Thus, as argued above, dollar depreciation from 1985 was viewed with relative equanimity in Europeי

and Japan. The very sharp depreciation of the lira in early 1995、on the other hand, was severely criticized by France, which cren invoked in Brussels the possibility of raising duties gainst Italian exports.

ex&^ge rate to lower unemployment is fblt to be pursue internal balance, legitimate। as is the imposition oftariffs to improve

In a wprld in which unemployment is widespread (clearly Ще case of Western Europe since 1973, IV. COMPETITIVENESS AND tbcy^ιnσtoftheUSA∞d⅛ρan‰thetemptationto EXTERNAL BALANCE usedepreciation to raise domestic employment will aM&ys.be present (esp8ia∣ly if large public debt As argued earlier, countries may feel that external levelsmhibιttheuse٠fexיionaזy fiscal ^licies). balans is a reasonable aim for policy which could There is a parallel here with the optimum-tariff be thwarted by an inappropriate level of the real argument for protection. Since governments are exchange rate. Ensuring the right degree of com-

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marketsis virtually unrestricted. Hence, it could be possibly more important, proviso. For a variety of reasons, many countries exhibit a revealed prefer-argued that 'the external constmint on national

rate,(C⅛> 1994, p. 272).9

to fîname current-account deficits need not always loss of face or reputation, but there are also other.

that has been incurred, via future current∣accouni have been successful is still debated. Except in

could well end with a ณท on the currency. Most that the unemployment consequences of maintain- 8untHes would fĩnd the latter option undesirable ingahigh exchange rate will t>ecome progressively

and Mexico in 1994).

6

since experience shows that it usually leads to both restricttvepolic1esMdhigherinflation.

in practice, given the un8minties which surround estimates of the equilibrium exchange rate and the

Best, thereibre, to depreciate the currency. Yet, as forced on countries via runs on the currency (pos- mentioned al)٠ve,sÉa^Hcymayn٠t be that easy sible examples beingltaly,theUK,orSpain in 1992,

suφluses. If today's current deficit, however, is ιsinwhichthe^licy'scredibility is veσquickly mainly used to bgst domestic consumption, then established on lal×)urmarkets(something for which automatic adjustment will appear unlikely to for- there appears, so far, to be vinually no empirical eign-exchange markets. Blowing may become consimiation whatsoever), the real exchange rate increasingly expensive and the whole experiment appreciates. The lbreign currency markets, fbaring

macroeconomic management of the 1950s and see fbr relatively fixed exchange mtes. This is I960sisnolongeropefative'(Cooper, 1987,p.542). clearly not true for large and relatively closed A decline in external competitiveness>∞danensu- 8onomies, such as those of the USA, Japan, or ing cuιτent∣account desicι‰g could always be a٠। Russia, but itbmes increasingly tme for the more commodatedbyboιingor>altematively∕ofιset open Western (and Eastern) European economies by an appropriate depreciation of the exchange and fbr many developing countries. Most manage

B6h the bogwing and the depreciation prescript currency (be this the Deutschmark or the dollar), tions fmt fold Ỉn this relatively complacentview Misleadingnotions ofprestige may sometimes de- do,hσwever,raiseιeproblems.First, boπowing teπnine such attitudes> depreciation being seen as a

their exchange rate in some fbrm or other and a number have chosen to peg it against some key

unpredictability of foreign cuιcy markets' be- Altematively, countries (especially small ones and haviour.Buteven ifatimely and appropriate depre∣ esp8ially in Europe) haverit that exchange-rate ciation could be engineered, there is a further, and changes were not, orwere no longer, effective in re-

less acceptable to the policy-makers, may then precipitate a crisis. Thus, on a number of recent occasions, eventual exchange-rate adjustment was

* As is well known, the current bdance (مد-د is in accounting terms (almost) identical to the domestic savings-investment balance. (S-。+ (Γ- ՃՆ where (S-今 stands for the private sector's fìnancial surplus and (丁一 G) for general government net lending. For low competitiveness to generate a current-account deficit, corresponding changes must also occur on the right-hand side of the equation. The most obvious one arises from the lack of demand for domestically produced tradables. This, by raising unemployment, will depress incomes and, therefore, savings as well as tax receipts.

9 Such a depreciation could be achieved either by letting the nominal exchange rate decline or by lowering domestic wages. Put so s*addy,the∣atterpolicywouldclearly seem sub-optimal, given that nominal wage rigidities arewidespread. Yet, İnan international economy in which inflation rates are positive, tηring to curb domestic wage pressures relative to those of the rest of the world, may be pefsecHy sensible since it could contributcto achieving both intemaj and external balance. In the circumstancesofthemid- 1990s. however, when inflation rateshave been reduced to very low levels throughout theOECD area, funher domestic de∏ation risks being very costly indeed (Akerlofer all 1996).

beoptimal. It is, in principle। desÜe if the deficit and more serious, reasons fbr shunning exchange- reflecte different inter∣temporal pref⅛ren8s be- rate adjustment. tween saving and spending at home and abroad, which aro seen t٠ be selfcdtingthroughtiπ1e.A Some of these reasons have to do with domestic country may borrow foranumberof years to raise am∣∙mflalionajyaims∙lnflaHon∙prone8untrieshave, its rate of investment The greater resources this at times, chosen to Ax their nominal exchange rate investment (hopefully) generates will then be used to an outside 'anchor，so as to reduce domestic to service, and eventually repay> the fbreign debt wage and price pressures. Whether such policies

А. B٠ith٠

what would (initially at leas。appear as an uncon-establishing external balance. Indeed, the move

V. DOES DEPRECIATION WORK?

changộ-rate instrumentaves perversely·-၊« def।٠ In the Bretton Woods day a devaluation ofthe currency cit leads to depreciation, which leads to a farther could have been viewed by most firms as conferring a desicit,|vhichfuelsiu⅛rdq)reciation>etc. Stabil∣ semi^rmanent competitive advantage. This, In turn.

7

1980§ and into the early 1990s. The fbllowing will took at some of its possible causes.

wouM set a lower bound to the value of the ex- change rate| given that the country's competitive- nesswillhavebeen seen to have improved byaveσ large amount, but in the meantime the currency would clearly have overshot its equilibrium level as it does, if fbr different reasons, in the well-known

The oldest criticism of depreciation goes under the weH∙known name of‘elasticity pessimism‘. If the priceelasticitiesof demand for imports and exports are low and the Marshall-Lerner 8ndition for a suc8ssfUl depreciation is not fulfîlledjo the eχ.

Doubts about the effectiveness of depreciation in restoring the in<emationaJ ιpetitiveness of coun∣ ⅛abound∣A(πon∣exhaustive>list would include:

small exchange rate changes may elicit no price or quah- tity response; for larger exchange rate variations pass- through is again incomplete; and the system may exhibit bysteresis, whereby temporary exchange rate changes have permanent effects on import volumes. These argu- ments all imply that an exchange rale change of a given size may be both less predictable and less effective in securing balance>of>payments adjustment than is sug- ges½dbythetraditiona!elasticitiesapproach (Venables, 1990,p.25).

In addition, non>pricefhctors(suchasquality,avaiμ ability, after salesτervi8, etc.) are, of course, very important in explaining longer-ณท trade ^rfoπn- ance, as underlined by Fagerberg's contribution in this 1ssue."Indeed,theirimportance in recent years may have grown, as the share of price-inelastic goods in world trade has risen.،2 And the value of price elasticities may have, similarly, been !owered by the move to floating:

themore profitable export or import>competingactivities. In the world of Coating rates experienced since the early 1970s,the persistenceof such exchange rate changes has been limited... In such circumstances Ask averting sirms٠ responses to sudden depreciations that are viewed as

ιu The well-known Marshall·Lemer condition states that a depreciation will improve a country's trade balance provided that thepriceelasttcitiesosdemandsorthatc0untry>se×poitsandjmp0rtssum to more than one. The condition assumes balanced trade at the outset (if there is a deficit the condition is less stringent for the current account expressed in foreign currency terms' and afull ·passthrough' from depreciation to impon and export prices. In other words, fora 10 per cent deprecation, impon prices (in domestic curτency)rise by 10թր cent while export prices(in foreign cuπency)fallb>Ι0percent(see⅜ e.g.Caveser∏Λ.1990).

" A recent analysis of expon performance in 14 OECD 8uniries shows that, while changes in relative costs have the expected effects on trade flows, there are, in addition” significanttrend influences on expon marketshares which must геПесІ non-price Factors (Carlin e,M.. 1996). ''Thus, the share in total OECD exports of standard international trade classifìcation (S1TC) category 7 (which consists mainly

of investment goods), changed little between 1965 and 1980 (iι went from 34 to 35 per cen) but rose very rapidly (to 42.5 per cent)betwcenl980andl992.Sim։larly,theshare٠fexp٠rtsof٠high-tech١productsmovedonlyfroml2.4inl965tol5.4in 1980. but then jumped to 22.5 per cent between 1980 and 1992-

towards European monetary union(EMU),which is trolled downward spiral of their currency. backed by a large majority of the Eυ*s member ๓นทฟ٥ร, is implicit proofthat the exchange rate is There are numerous reasons why price elasticities not(ornolonger)seen as an essential instrumentos in international trade maybe relatively iow.Market ^tionale∞nomic policy. Such ،depreciation pessi∣ structure may matter. Thus, in conditions of imper- misπ1* was particularly widespread through the factcompetition:

(i) low price elasticities in world &ade; ;affect the real exchange rate inability t٠ (ال) (tii) unpredictabilityofdepeciationefflcts; (iv) perverse longer-run impacton non-price com-

petitiveness.

ity ၊Id eventually be ensured since expectations woutd have led t٥ long-term changes in strategy as firms reallocated noi only production, but also investment, to

temporary may be a quick increase in sales but not a ‘overshooting modeľ ٥f D0mbusch (1976)• Few commitment to a long-run switch into tradable produc∙ glicy-makers will countenance with equanimity tion. ТЋе short-run elasticities may actually be somewhat

フ季キ丁广

axFOROBEwoF ECONOMIC P٥L।C٧.V٥L. 12. N๐. З

higher as a result of such behavior than they would foreign currency) would similarly doub® give or

presence of real wage resistance. As so often tn economics, however, assumptions can sly in the ^ssib∣e,em∣ms for wage parity across the country face of reality.

variables—prices will rise following the fall in the rateatthetimeofits 1982 EMSrealignment(in part

8

otherwise have been, but the long-run ones would be 10wCT٠(B٠hh0,1987։p٠593)٠

obviously aplies in cases in which domesticmoney supply doubles (the son of example oflen given in textbooks). In such instances, both inflation and the

more.,5 In any case, even if real wage resistance were present, it would be unlikely to persist for

Turning to real wage resistance, also discussed by Dornbusch in this issue, iflabour does notaccept the cut in real wages which a successful depreciation

would very quickly undo them. At^e national level, however, such astate of affairs is much less likely.

currency's value and the real exchange rate will thankstoasuccessfulincomes^licy)andmaintain remain unchanged. Money neutrality of this kind that competitive advantage for the next decade and

⅛vety influential monetarist position, by postulat। Wage levelsstill difflr importantly, even within the ing the axiomatic view that money is neutral, 8n٠ highly integmtedcountriesofWestem Europe.14 As c^es that any change inanominal variable, such as small and open an economy as, fbr instang, that of the exchange rate, will be unable to affbct real Belgium was able sharply to alter its real exchange

take a few percentage points. But homogeneity of this kind is much less likely to apply to the plus or minus 10per cent changes that usually occur in the real world, the more so if there is less than քն।1 employment and ifpoι1c1es in thedepreciatingcoun- try are non∣accomm^atrng⅛Evenifmoney neutral- W were accepted, the gsult may only pertain to the long(or possibly veσ long) run. In the interim, real exchange-rate depreciation would have improved intemational competitiveness and facilitated the achievement of both extemal and internai balance.

YeLhoweverplausible all these arguments are, the empmcal evidence, partly surveyed by Rudiger Dombusch in 命昭 issue> still suggests that the price elasticitiesofaemand which are today encountered on world markets are sufficient, indeed more than sufficient» to fiilfil the Maraball-Lemer condition. And the likelihood that exchange-mte changes will elicit cunțnt٠account improvements is strength- cned by the knowledge that the supply elasticities (which are equally lial fbr successful adjust- men¢)" Will, in most real world circumstances, be positive.

” Most industrialized countries wiłl have fiι selling on both perfectly and impe⅛tly competitive world markets. For the latter, price elasticities of demand will matter. For the former, however, (foreign currency) prices will be given and exports will rise only if domestic supply elasticities are positive ” In 1995. for instance, the hourly wage in German manufacturing was nearly two-thirds higher than the equivalent French one

(as against a 50 per cent differential 25 years earliσ). Taking similar figures fbr the six founding members of the EC suggests that, ovσthe 95-970 ل time span, there was littleconvergence—the coefficient of variation rises from 0.2] to0.23 (Institut der deutschen Wirtschaft» JW T>8"dk, No. 2.1996). Broadly similar results are obtained if instead of using market exchange rates, one uses the 0ECD٠sest،mates٠fPPPexchange rates—٠the coefficientof variation declines only marginally from0.l7to0.15(andGermany∣s hourly wage in 1995 is still 52 per cent above France's, against a 45 per cent differential in ∣970).

” In 1982 Belgium lowered the value of its currency by 8.3 percent within the EMS. Its real exchange rate between 1981 and Î983 sell by nearly 25 pcrcent(concomitantdollarappreciaiion was. ofcourse, alsoplayingan importantrole). By ]995,Belgium's real exchange rate was still some 15 per cent below ils 1981 level (despite a 7 percent nominal appreciation in the period).

A seconded pssibly more justified worry about requires, initial gains in competitiveness will be the un⅛irebilityofdeρreciations ás from fears quickly eroded by acce!erating wage ؟nflation De٠ thatnominaldepreciationswiilbeim∞teπtinalter> preciation in such circumstances cannot work and ing the œa। exchange rate. This view has two adju∣entcan onlycomeviaexpenditure reduction variants which come from opposite sides of the and rising unemployment. Yet, here too, sears can spect၊।-ne ٠-٠ lassical economists ιh the con- easily be exaggerated· Complete real wage resist-

eve—|hensingunemploymentitgeneratesisboun& exchange rate (expressed as the domestic price of through time, gradually to erode it.

elusion by assuming the exiỀceosmoney neutral- ance, and hence an endemic Eck of competitive· ity; some neo-Keynesian ones by assuming the ness, may well be present in the regionsofaunitary

state. In these, even if nominal devaluations were

А. Boltho

А difïbrent objection tø depreciation stresses the ⅛chιelsoftransmission,theendresuhwouldbe uncertainty of its impact, at least in relatively open tha1 depreciating countries move down market，

chases because of increased inΩationary exρeeta- ciationcaπ provide an opportunity(whichcould⅜ of

domestic demand٠ If a current deficit needs to be would notonlyrduce sales in the short run, but, by

domestic absorption, other welhknown channels The scanty evidence on this whole issue is, inev≡ta-

seem valid.

9

high-tech) goods; it slows down resource reall٠ca٠ tionbygivingabreathingspaceto firmsand sectors

A final (and less orthodox) worry is that deprecia- tion could have unfavourable longer-run effects on non-price competitiveness which could more than offset its favourable short∙mn effects on cost/price

tions). Asaresulζthedepreciat1oπ>sdirectfavour। course> be squandered). Appreciation| on the other able elts on the trade balance could easily be hand, particularly in conditions in which labour offset, or even more than offbet, by a large rise in mobility and downward wage flexibility are low.

such as Japan. South Korea, or Taiwan, 'expand their share of world markets, not by reducing the

competitiveness (Tbirlwałl, 1980). The reasons fbr while unrelated changes on the supply side of the thiscouldbenumerous—depreciation favours spe- economycould be responsible for long€r־run trends, cialization on price*sensitιve (ฟ presumably non Thus, rapidly growing and successfbl countries.

ment)⅛ Surely» the view that successful adjustment engineering exports (Brech and Stout. 1981), and wιllιnaiiy require both expenditure reduction and the evidence assembled by Fagerberg in this issue, expenditure switching (Johnson, 1958) would stilt on the so-called ،Kaldor paradox' shows that im~

exist throu^1 which a lowering in the value of the bly perhaps, ambiguous. An earlier examination of currency will have opposite effects (Alexander, France's 1969 devaluation suggested that this had 1952)1 Andexclusivereliιeonsiscalpolιcy^while been successful in encouraging rapid structural n٠ doubt eftbctive in reducing an external imbal⅛ change(MistraU l975).Amore recent econometric 8n8, woutd come at the expense of a sharp wors- ening in internal balance (i.e. a rise in unemploy#

proved cost competitiveness is not correlated with growth in foreign market shares over the longer term. Yet, reasons for the ςKa1dor paradox' need not be found in some perverse effects from relative cost or price changes. The latter could still afíect trade flows in the predictable way in the short run.

study, on the other hand, showed a negative link between depreciation and product quality for UK

otherwise threatened by bankruptcy; it encourages relative prices of their goods, but by expanding the ،x-inefficiency* since Kdefacto, providesafom of rangeof goods that theyproduce astheireconomies protection from foreign competition, etc. Whatever grow'(Krugman, 1989, p. 1039).

'8 Taken to its logical conclusion, economists defending this position should recommend appreciation for countries beset b> cxtemd problems. Academics, even when sceptical about the virtues of depreciation, hesitate| however, to adopt such 3 view. Governments seem less inhibited. France's midi ∖ 980s conversion {Q^francfart policy is clearly based on the ultimate belíeťthat the economy will do better under an appreciating currency than it did under a dcprecia1rng one in earlier decades

reduced 'inapredictablefhshic>n, one must operate squeezing profits, could also penalize the tradable onthcec٠nomy٠ssaving٠ínve٠entbalance٠(ibid٠٠ sector in the longer run. p. 34), le. by restricting fiscal policy.

economies with floating exchange rates: ،the effect relative to the more successful appreciating ones٠i٠٠ osdepreciation on the balanceoftrade is ambiguous in the short run and nil in the long run> (McKinnon> A diametrically opposite view, however, is also 1990, p٠(3 ٠ و This is not because of 'elasticity possible—depreciation| by raisingthe profitability of pessimism',butbecause,it isargued,depreciation, the tradable sector, could allow firms to improve which is contingent on monetary easing, raises non∣price competitiveness over the longer run(by> domestic absorption (by, e.g. attracting foreign di٠ sor instance, generating the funds needed for more rect investment (FDI)∣ lowering the domestic real investment, higher R&D spending, or sales and interest ؤد and encouraging anticipatory pur٠ advertising campaigns, etc.).lnotherwords,depre-

Which of these two possible responses predomi- While itis» indeed। possible fordepreciationto raise nates will, presumably, depend on time and place.

⅛E⅛0F ECONOMIC POUC٧٢V٠L 121 NO.3

Despitethenıany doubts thβt surround the useofthe VI. COMPETITIVENESS AND PRODUCTIVITY GROWTH

teπnsof^de deteriorations which lower domestic

Even irιinalexchange-ri⅞te changes are eventu٠

suffer from permanent losses in market shares. this by raising productivity than by lowering the

could avoid such consequences.

10

exchangerateasashart٠n။t₽٠licyinsti٦1men^m〇st of the evidence would suggest thatit can be effec⅛

nominal wages) since the effects on real income would then be unambiguously positive」。Such a

which Леке is no certainty)। depreciation can, in the. over the last 20 years the average (trend) change in interim> bringabout a UỂ1 and relatively painless the terms of trade (irrespective of sign) has been of cuti® real wages which willhelp to raise outputod only 0.6 percent per annum. For the six countries empby1pent| And such gains could turn out to be with worsening terms of trade, the average (trend) knprtM‰ re∣at∣ve to the counterfactual» ؛shyster، deterioration was of merelyθ.5per cent ρerannum.∣s esisis^sentintheeconomy.Ratherthan bouncing baciata some immutable equilibrium» an economy Yet, if an improvement in competitiveness was with @temporarily overvalued exchange rate 8uld desired, it would still make more sense to achieve

tiv∙Mcha⅛⅛gcxtema1pwkionsJ"Γhkwascleβriy There is, however, an important ejection to ex- 90 for the m⅛or exchang&rate changes that ٠c٠ change⅛ratedeF1ation which has only been briefly cιmcd in 1٠987ح between|<he dollar the yen, ฟ mentioned so sari-depreciation usually leads to theDmits^hmirk. The ،coẁýen^onat wisdom That

” Recent changes in the perception of the effectiveness of depreciation are shown by the changing naiure of the EMU debate. When first launched in the early 19905♦ proponents of the project argued ιhat giving up the exchange-rate instrument would entail only small costs, since nominal exchange-rate changes were virtually unable to modify real rates. By the mid-1990s| proponents were arguing that EMU was necessary because nominal exchange-rate changes were so eΠective in altering competitiveness as to endanger the workings of the European single market.

٠٠ A simple cross∣section regression for 19 OECD countries between {trend) changes in the terms of trade and (1rend) changes in real or nominal exchange rates results in stattsticaily insígnifícani eoeffìcíents.

There isan exception tú chis general rule, that ofso∣caNed *ímniíscrizing growth| (Bhagwati! 1958). but sor most countries this יי is no more than a ιheorettcal curiosum.

areunliketytohavebeen dramatic. This is probably ٠।।y 自0٠，eroded by higher ；prices (something on alsotme ofthe longer mn.For theOECDcountries

permanent rises in unemployment, and permanent nominal exchange rate (let alone by trying to cut shortfalls in the capital stock. Timely depreciat1oπ

how P٠rs٠stentrøalexcbge٠rate depreciation can| depreciations may have been somewhat Erger, cfWIy{fhelpd by significant inflows ofsoreign given that Western Euroρe,s overall terms of trade direct investment in high-tech areas, confer large improved during this period, thanks to the relative gains ؛nc٠mpctitiveness٠ weakness of oil and many commodity prices, but

even then, other than sorFînland, the deteriorations

aBmbínígGnofappmecMkmS/depreciationsand real income relative to the level it would otherwise d٠।»٥٠t،c absørption/disa^rption policies would have reached⅛ This may not matter much sor large brii٠g٠ut Iģge ٥mt balance adjustment was countries, such as the USA, in which international ythatq>cr٠ence(Kn1gman> 1991)∣ trade plays onlyalim∣tedrole(Kj*ugman> 1994), but<٠ic٠٠٠d।٠^fulי

De٠٠।1।٠ Ỉn Western Ewτope in thewlyl990s٠ it could be more serious sor those smaller ones ass*rγW⅛WbyDombusch"Mh1s1ssue,alsostrong∣y (probablythemajorityιongtheindu^al⅛ed∞υn*

” s⅛⅛t ٠၊t٠ SỢ ŴT &t le&4 the depreciations of wιes)whichdo not face termsoftrade set by the rest ا9سعل 1992 Wereh٠eí1Iy٥٠>dfU। in improving of the world. In practice, however, the effects are extermi Ma٩ces٠ Similarly> Ntearu Yoshitomi's unlikely to be veσ large. The experience of the contti£fQn to tn>s issue i⅛Qwshow Japan*s trade European economies which depreciated in the early ac¿e^sinth。198〇sw٠r^achíevcdn〇t(٠٥0<ten 1990s shows> so； instance| that in J 2 years

th٠٠) i¢ paraH٠। with c٠rttin ؟٠ us real apprecia- following the currency changes, temseCtmde ti٠n٠ but in the presence» if»rtỳthíng♦ ofa fr٠٩uently deteriorations ranged between ]0 percent in Fin- unđ^alweđ cunρncy∙ Finally♦ [gland's experi∣ land and 1 弘 percent in Britain or Spain (Table]). ٥٠٠«, 4⅛c∣∣1 in Brendan١Walsh٠s article, shows The changes which can be directly attributed to the

100

100 101.0101.2 101.8

i"&*e elnaì equilibrium;depreciation will do. incomes. Location matters in many industries. One

inflows, they can ако attract FD1 by lowering their

issue of the puny size of the possible gains from for international competitiveness and that to attract

။

litHesnHe&ionwiQitheissueofintemationalcom- petitiveness unless it could be shown thaζ in some

s as a consequence of the sharp rise in the sizeل 990 of FDI Hows (UNCTAD, 1995). The end result

97.4 98.7 98.5 96.5

Retaliation isone⅛ger. The likelihcκκi of ،govern- rateos inflation, improving theιrinfrastructure, rais־ mentfoilure, is another, since the information re- ingthe level of education andtrainingoftheirwork- quired sor such policies tobeefïectíve goes usually force| opening theirmarkets to foreign competition, we∣∣ beyond the bureaucrat|sknowledge(Grossman, deregulating some aspects of their economies, etc. 1986). And Krugman's devastating example in this In other words, the perception that FDI is necessary

89.8 98.4

101.g 100 96.0

Finland Italy UK Spain , Sweden МетогЫ၊ item: QECDEumpe

96.2 100 100 100 100

脅飴:単やケ &pr8iatedinNo?ember 1991 and, again： in September 1992, Iyly and the Undepreciated in 아篇±票86 丄 $ح¢၊) inNovember 1962, while Spain devalued,「ithinthe EMS, in September

1992, November 1992 and May 1993. %w OECD, Economic Outlook) June 1996. stance y?ould seem to be the one clearly preferred policies ofthis kind, shows tha‰ even if successfill, byEør*#'spolicy-makers*menlookingatway$to theirempirιcal significance would be τn1nιmat. better 뺘 ama's dismal employment record and mo٥٥s٠ gr ٠١׳* ŵ performance, ways which are dis٠ There is, however, a potentially more important eussçdiliLlewe]।>n*s٠٥nUibutiont٠ this issue. The channelofaansmission. AnthonyVenables> article focus of attention now shiits to the longer 1. For in this issue shows how agglomemtion forces can as٠m।p(١û¥efna١t in competitiveness designed to lead,to positive external economies and higher real

producuvrtygro|vthattheexRseofforeigncoun- international competitiveness by subsidizing FDI tries# In practice, th IS ιshighly unlikelyto be the case.

areas at leβsζ gains inonecountfycouldbeobtøined ∞uld bemerelyatransferofinιefrom domestic at the expense of another one. Two instances of tax payers to foreign shareholders (and, at least in such potential conSict can be given. The use of Japan.also workers)of multinational companies, suategic trade policies, fbr instance, by shifting the location of high value-added industries to the do- Such zero-sum game outcomes are not inevitable, mestic economy, could in theory promote national however. While countries can try to raise their

Fora !qηger-πm improvement in growth perform֊ way in which to strengthen such localization effects ance٠afctn٠0retimewiilbe!١e٩uired-၊-an।lera٠ wouidt>ebyattractingFDI inflows. Ỉreỉandיsappaг٠ 'tMM1θf∙κMctiviγgrowth, ifatallťřasible, must entlyveσ successful ỉndusưiai ^licyinthisarea,as ■wait ⅞ιp⅛ increases in investment and in R&D discussed in Walsh's contribution to this issue. spe∏4iι⅞g⅜ It may also require reforms of the educa- providesapossible empirical i∏ustration.⅛obvi- ti<m ∣∣nd *mining system, or even changes in the ous danger of such policies, however, is that they gguiatdfyenvironment can Ieadtocompetitivebiddingby variouscountries

to entice footloose capital to their own jurisdictions. AI∣Λis,hoκκr,isdesirablein itso|vnrightandhas a danger that has become more apparent in the

A. Boltho

19941992 19931991

Table 1 Terms of Trade Developments in Selected European Countries

(ratio of export to import unit values; indices: 1991 or 1992 = 100)

٠٠ مه

ح 1

3 ص

^ ٠

5 9*م・

• OXFORD REVIEWOF ECONOMIC POLICY, VOL. 12, NO. 3

٠

•

4 1995).

• Thisdìscussîon suggests that the worry with longer- counưíes are in economic conflict with each other.

terms of trade would also improve.

and privatization inthecountriesofEastern Europe, certain. The conventional definition of the real or labour market and welfare state reforms in the exchange mte which has been used in this assess- EU. The USA may be somewhat impervious to ment (relative unit labour costs in a common CUT।

priate policies towards, sor instance, savings, as non-tradable to tradable prices) would suggest ap״ persuasively argued by Hatsopoulos etal.,(My). preciation.Inpractice,muchwilldependon⅛ges Smaller economies tend to be not only more open. inthevaluesofthe incomeelasticities of demand sor but also more open-minded, and therefore much exports^d imports. Should rapiddomestic grovvth

12

Prcdιc(ab∣y. perhaps, the soπner recommended wage moderation lo strengthen competiiiveness, while the latter concentrated״: on the need sor productivity growth and deregulation.

more willing to learn from other countries| expert- ences.

foreign demonstration effects(even though its com- rencyX would suggest depreciation; thethιtical petitivenesscouid greatlybenefitfrom more appro- definition mentioned insection∏above(theratioof

course, be addressed by destructive policies such as import quotas or subsidies to exports. Nowadays,

make for persistentcuιt∣accountsurpluses> ιe appreciation wi!i be inevitable. For the I955-65 period it was suggested that there was little trend in

the world in its White Paper on Competitiveness (1993)، Nor do such bodies subscribe to the idea that

Even if a sew participants in the American debate may use the notion in order to advance the cause o£ sor instance, managed trade, this seemsamuch less serious danger when seen ữom a European per-

strains the imagination to believe that protectionist urges may lie behind the preoccupation with Ger- man competitiveness, as frequently voiced by such

Thus, it is difficult to see the UK government's real exchange rates for وا major industrialized concern with the country's comparative perform- countries. For more recent years there seems to be ance (HMSO, 1994, 1995) as translating some a positive relationship between bnger-run output hidden agenda for interfering with free trade, and it growth and appreciation if Asia's newly industrial·

they seem much more likely to' elicit opening and Whether such faster domestic growth leads to seal liberaüzationinthedevelopingworld,deregulation exchange-rate appreciation or depreciation is un٠

run competitiveness need not, a^er all, be as dan- gerous as Krugman ilars. Since the competitive- nessof individual firms İssignifîcantlyinfluen8d by domestic policies(e.g. on education and training, on

policies in ways that most economists would impeccable desenders of open markets as the favour. Indeed, the growth acceleration regrded Deutsche Bundesbank (e.g. 1995) or the German by a number of developing economies over the Council ofEconomic Advisers(e.g. Sachverstand- last two decades has been primarily ascribed to igenrat, 1993).2° As fbrthe European Commission, successful reforms ofthιs kind (Sachs and Warner, it specifícally advocates openingtowards the rest of

it one needs, inter alia, both domestic stabilization andexternal liberalization,has often forced coun- tries to modify their macroeconomic and other

,

사

R&D and technology, on taxation and infrastruc∙ sective. ture, etc.), the concem with competitiveness is likely to raise awareness of international differences in Improvements in competitiveness achievea via an such areas (Eltis and Higham, l995).Awareness,in acceleration in productivity growth are likely to tuE,couldbringaboutre&"msand8nvergenceon benefít both the growing countrywdtherastoftłie better practices and ^licies(which need not always world. Not only will domestic incomes rise, but beAnglo-American!).Itιsalmostcertainlyeasierto import demand should be higher, new and better implementproductivity-raøngmeasuresbyinvok- products should presumabķenterthe world markeζ ingan imagined external dangerthan by appealing to and, if the country's growth is 'pro-tmde，biased economic theory. The *foreign threat tojobs| or the (Johnson, ]962), as will usually be the case in ‘need to be internationally 8mρetitive' can, of practice(Corden, 1994),then the restostheworld|s

А. Đ٠lth٠

Growthof:

GDP

(average annual % changes)

1.2 1.21.7

Ểgeconomỉes are included Ỉn the Iple| but none equilibrí um fromadeficit caused by an inappropri∣ for the OECD counties alone.기

Vii। CONCLUSIONS

The lessons for policy-makers would seem to be

from unemployment may wish to improve its em- away in the 1950s and 1960s and, despite some ploymentpositionattheexpenseofforeigners.The resurgence between the mid-1970s and the mid- outcome of such action is clearly sub-optimal. Re- 1980s, has retreated even more rapid» over the Est

٠e:٠ 1992-5. Source\ OECD, Economic Outlooki June 1996.

Total domestic demand

"For the 23 OECD and newly industrializing Asian economies (NlEs) for which real exchange-rate data are available ( in the 0ECD١sfc ٥»٥ wc ٥٥»//٥ ģ), the rc!ationship between trend appreciatio∏(RER)and trend GDP grovMh(∆Y)over the period∣976- 95 is a$ follows (t-ratios in brackets):

The short-run international competitiveness of a ever|the world should befit in the longer run from ∞untty has, in this assessment, been equated with a more appropriate pattem of exchange rates, trad- the real exchange rate (defíned as an index of able production, and current accounts. mlativeunit labourcosts inacommoncubency). An improvement in competitiveness thus involves de٠

tałiation would be likely and world welfare would decade or so, contrary to most observers' expecta- decline. In the second case, a country may wish to tions(Boltho, 1996). ‘Exchangerateprotectionism' restore its extemal balang to a position of desired (Corden, 1985) does not appear widespread. Ger-

clines in the real exchange rate. Such declines will relatively straightforward. Beggar-thy-neighbour usually∞mefrom falls in the nominal exchange rate policies, whether in the form ofprotectionism or in (risesin labourpråcuv1ty,otherthancyclical,are the form of aggressive depreciations, have we٠J٠ unlikely in the short run). Declines in the nominal knowncosts vivdy illustratedbytheexperienceof exchange rate could, in turn, be motivated by two the 1930s. Behaviour since then has greatly im- policy aims. In the first case, a country suffering proved. Trade protectionism was gradually whittled

ately nigh real exchange rate. If the move is ac- cepted by the rest of the world, worM welfare at a first approximation would not change—Thedepreci- atingcountrywould improve its trade balance at the expense of the appreciating ones. Arguably, how-

0.1 1.3 2.8 1.3 1.1

-6.0 5.3 1.0 1.2 3.0

Finland Italy UK Spain Sweden МетогЫит item: OECD Europď

R2 =0.41 SE N I.23

-3.0 -0.3

2.2 Ø

-0.6

This suggests that trend growth rates of more than 3 per cent per annum are associated with real appreciation. The results arc. however, dominated by the observations for the iourNIEs. The relationship breaks down when estimated for the ()LCD countries alone.

Changes in primary structural budget balance

(in % of current price GDP)

Table 2 Changes in Demand, Output and Fiscal Policy in Selected European Countries

(1991-4 for Finland; 1992-5 for other countries)

RER= -I.49+ 0.50 △Y (31) (38)

OXFORD R≡≡0F ECONOMIC POLICY.VOL 12. NO.3

many and Japan were at the forefront of efforts to dued, forthe first 3 years after the currency change.

did their best to try and invert the movement.

ever, tħatsιssiul depreciation, even in condi- wage and price moderation in such circumstances.

∣9*0QJT9G3Q4n9B0Q3∙ Ig) 1992Q3-tq95Q4(∣992Q3 파 100) Real

Nomini। Real Nominal

∣8K ion 1983 t^3 1994 1905

(٥)UK

∣9%O∣79"Q±1∣9%Q1 ■ I٠٠> I9Q2Q3∙1QQ5Q4<∣82Q3. 100)

Real Nommai

Nominal

Real

1977 19% |Q7٩ ∣Q012C1 R4

14

N3e; * Relative unit labour costs. Sources՛. Bank of England.and IMF.

stopthedollarfrom rising fturther in the mid-1980s. Similariy, when markets buffeted currencies in Western Europe in thecouι⅜eofl995^goveιents room made for the improvement in the ⅛ade baí٠ seced|vithrapiddepreciat1ons(∞despecia∏yItaly), ance, but wage inflation was also kept at bay.

as the authorities, except in Finland, tightened their fìsca! policies (Table 2). As a result, not only was

contrary to what had been expected by most ob٠ servers.InbothFinland^dltaly,thisoutcomewas|

110

105

100

7$

Hons ٠f less than full employment, must include ٦15آلثم is vividly shoì by thecontrasting experiences somed^reeofexpenditurereduction.lnall the five of depreciation of both Britain and Italy at the turn European counưies that saw depreciation in the ofthe l970sand in the early 1990s(Figure 1).61 the earlyl990satatimeofdomesticrecession(Finlωd, earlier occasions, gains in competitiveness were ІЫӱ٠ Britain, Spain, and Sweden), the growth of very short-lived as inflation accelerated, despite domestic demand remained subdued, or very sub- relatively high unemployment levels. A major rea-

10S

85

Somedepreciationsare,however, inevitable. When in addition, im1>ortantly influenced by vety success- a8untty is clearly uncompetitive, restoration of ful incomes policies. extil balance should involve a fall in its real exchange rate. Despite all their faults, foreign- Uitimately,themajordifficultyofa∏icyofdepre- excban#emafkets have frequently operated in such ciation is that it cannot be repeated too often, quilibratingways. Recent experience shows, how- precisely because it will be vety hard to ensure

110•

85

197&

။s١ ■ d

105•

Figure 1 Nominal and Real■ Exchange*rete Developments

(a) Italy

А. Boltho

appreciations since about 1986-7). vention (e.g. in the USA), in smaller open econo-

Some domestic policies designed to improve pro- need not change much. Yet, their combined efforts ductivitygro‰vthcou!dbeofateggar-tħy-neighbr would increase world welfare.

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15

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