summaries

Note 1 1. See Krugman 1994.

The Economics behind the World Economic Forum's Global Competitiveness Index

References

B⅛⅛d, ๐. 2004.ĩhe Economic دج of E၊pL7 ״٥ um٥Z؟/rE।mzcPerspech٠es 18/ no. 4:3-26.

Krugman, P. 1994. "Competitiveness: A Dangerous Obsession" Foreign ٠rrs 73, no- 2 (March/April): 28-44.

Prescott,E2004."Why Do Amedcaι6 Work So Much More than Europeans?" Fede?0Z Re- serreB،znk٠ínne٥p٥Z0 QuarterlyReσieu>28,n0∙ 1:2-13-

Xavier Sala-i-MaẾ

Competitiveness is defined as the set of institutions, policies, and fac­ tors that detennine the level of productivity of a country. The level of productivity. Ỉn tum, sets the sustainable level of prosperity 1±1at can be earned by an economy. In other words, more competitive econo­ mies tend to be able to produce higher levels of income for theừ citi­ zens. The productivity level also determines the rates of retum obta⅛ed by investments in an economy. Given that the rates of retum are ⅛e fundamental detennMants of she aggregate growth rates of the economy, a more competitive economy is one that is likely to grow at higher rates over ־the medium to long run. Thus, given that produc­ tivity has both static and dynamic implications for a country's stan­ dard of living, an alternative (although ahost identicai) definition of competitiveness would be the set of institutions, policies, and factors ⅛at set she sustainable current and mediιterm levels of economic prosperity.

Competitiveness should not be characterized as "a country's share of world maιkets for its products." As suggested by Porter (2003), the competitiveness of a nation is not a zero-sum game in which one country's gain comes at the expense of others. It is important to ет- ρhasize What this is a Hawed definition of competitiveness because it has been widely used.to justify intervention to tilt markets in one's fa­ vor. Countries have engaged in "industrial ρoHcy," provided subsidies, and devalued their currencies all in the hope of e)؟panding exports at their neighbors' expense, a∏ in the hope of improving a country's "competitiveness." Subsidies, however, shift resources away from the

： most productive activities, and devaluations (even when they are called "competitive devaluations") are nothing but a reduction of the price of one's products and are a signal that the firms are not competi­ tive enough. Moreover, devaluations tend to increase the price of

imported capital goods, which tends to make domestic firms even less competitive.

The World Econome Forum's Global Competitive Index (GCI) is based on three principles·

Market (macro factors)

Principle 1ะ Competitiveness Is a Complex Issue

Some of the best economic minds of the last two hundred years have asked what determines the wealth of nations. Adam Smith argued ihat speciation and ⅛e division of labor was key. Thomas MaNhus and David Ricardo, two of the best esnomists of the rEeteenth। tury, ־thought that natural resosces imposed a binding limit on the lev®, of prosperity. The law of diminishing returns meant that popula- tion growth would eventually require the use of low-quality land, and this wouid reduce production, per capita and cap the potential for eco- nornic growth.

The neoclassical econoÉts of the twentieth century emphasized i¤r vestment in physical capital ana infrastructures. The failure of many devebping countries to grow despite the aid of the donors proved What inviting in physical capital was not enough to generate aggregate wealth Economists, then, looked for other mechanisms: human сарі- tal, technological progress (whether created by. the country or cqpied from the leading economies), openness, macroeconomic stability, gov- emance, the ๗€ of law, institutions, lack of srruption, market orien- tation, govemment waste, Erm sop⅛tication, demand conditions, market size, and many others.

Each of ihese corjectures rests on solid theoretical foundations and makes economic sense; some even have strong empirical support. The central point, however, is that ·they could all be true at 1he same time because they are not mutuaUy exclusive. The main lesson from two centuries of eenomic thinking should be that ⅛e process of economic development ئ ra⅛ complex and many factors are needed for a country to succeed.

To think about the (8mρlex) determinants of productivity, we start with supply and demand (see figure 1.1). On ťhe demand side, Ље size of the demand (domestic and international) is key. The elasticity of demand with respect to price is also important (less-developed economies depend more on prices whereas consumers in advanced countries maybe less sensitive to prices .and more sensitive to quality or design).

Government

Supply (micro factors)

Figure 1.I GroỂỈ1٦two dimensions.

Demand

The factors that determine supply are also numerous: the quaEty of Ểastructures; the qity of human capital (in terms of its health and. in terms of its availabrnty and quaiity at the school university, and on- thejob-training levels); the incentives that the labor force has to work hard (which may depend on wage stoictures and how they relate to efbrt and individual productivity, meritocracy, and female paτtidpa- tion). Other elements affecting supply include the availability of tech- nology (not whether technology is invented in a, partic⅛ Cθιmtry but ՜whether technologies invented eisewhere can be used in a particular place); financial capital (the streng& of the banking system and the availability of alternative, more sophisticated ways of financing risky venture이; and institutional capital (such as protection of property rights, trust, and legal security).

Of 8urse supply and demand meet in the market. The efficiency of markets therefore represents the third comer of this triangle in figuτe 1.1. Competition in the goods market is necessary for firms to achieve maximum efficiency,■ and this competition depends partly on market structure and partly on government policies (protectionist policies, tax poĩicềs, and various kinds of regulation). The efficiency of the labor market and the financial market are also important to ensure ef&aency. Such efficiency can be broken, if she e∏yko≡ent becomes unsafe (⅛0m war, terrorism, or oủer kinds of personal insecurity).

Innovation Twelve РШагѕ To capture the complexity of competitiveness, we group the !foremen- tioned factors into twelve aιeas that we call the "ime∕0e pls of eco- nomie compå}eness." These pmars are:

Market (macro factors)

Supply (micro factors)

Figure 12 Growth in three dimensions.

Demand

At ťhe center of the triangle we place the central player in the econ- оту: the government. When we think of how governments operate to affect the competitiveness of an economy, we must remember that gov- ments ace sometimes moved by ihe desire to do good, but most ٠ often are moved by the desire to stay rn power and satisfy the needs of lobbies and pressure groups. And with this in Éd, they introduce reg^ations and legislation and foUow policies ⅛ιat affect each of'the comers of the triangle: from monetary policy, to red tape, to a legal framework, to subsidies, to protection.

she triangle is the base on whiả the third dimension is bu^lt: irmo- vation. We Ík of innovation as a third d⅛ension of the triangle be- came all of ⅛e factoιs at ⅛e base afect innovation (see figure 1.2). Innovation is not R&D. If done well, R&D may generate ideas. But be- fore ideas become productive they must be implemented by enưepre- neurs. And before they implement an. idea, ιhe entrepreneurs wiU look at a particular economy to see if the quality of the labor force and the availab□ity of technology is satisfactory, if the regulatory environment is favorable or if the size of the market is sufficient. Hence, although in- novation is a very important factor, especiaUy for advanced economies, we must understand that innovation cannot occur in the absence of a strong base: strong demand, strong supply, and efficient .markets in which supply and demand factors interact.

Γ⅛st Pillar btitutions The mstitutional. eÉoient farms ủe framework within which private individuals, f⅛ms, and governments interact to generate income and weaim ե 1776, Adam Smith argued that wealüı could not be created in a world where property rights are not well defined ฟ guaranteed. De Soto (2000) also defends ihe im- portance of the system of property rights. Owners of land, corporate s๒es, and even mtåectual property are uıürng to invest ỉn the im- provement and upkeep of their property if their rights as ovrners are insecure. Equally importantly, if property caιmot be bought and sold with the confidence that the authorities will ≡dorse the transaction, the market itself will fail to generate dynamic growth. The absence of property rights also drives people out of formal markets into the infor- mai sector. De Soto estimates that people in the developing and former

:communist countries hold more *an US$9 trillion in what he саЛѕ "dead capital"—property that is owned informally, but not legally,, and is thus incapable of forming the basis of robust economic develop- ment. More recently, an important and voluminous strand of empirical research confirms the importance of public institutions as key deterιm- nants of ⅛e current level of GDP per capita；

The importance of institutions is not restricted to the legai frame- work. Government attitudes toward markets and freedoms and the efficiency of its operations are aiso very important: excessive bureau- aacy and red tape,2 overregulation, corruption, d⅛honesty in dealing with public contracts, lack of transparency and trustworthmessz or ־the political dependence of ⅛e judiciary system impose significant eco- nomic costs to businesses and slow down ⅛e process of economic development.

Although the economic literature has mainly focused on public insti- tutions, "private institutions" aιe also important ingredients in ⅛e pro- cess of creation of wealth. Corporate governance, transparency, and accountability, for example, are sefen as important by economists wħo focus on the theory of she fimκ bargaining over the ex-post rents of a £rm becomes important in a world in which it is impossible to write contracts that fully specify the division of rents under all possible contingencies.3

Second Pillai: Physical I1ifrastructιιres A second important deteπrd- nant of competitiveness is the physical infrastructure 筑加アひ切ねの注・ For many years^ economic development economists『 practitioners, inter­ national institutions, and donors$ have emphasized investment in physical Ểastructures as a recurred ingredient in ihe process of eco- noÉc groẾ. Private films Ciθt operate satisfactorily in an econ∣ omy where it is hard to ⅛ansport factors of production, final goods, or services; where it is hard to communicate or transmit ⅛fomιation (because telephone lines are down a substantial fraction of the time or Internet connections are hard ๗ expensive); or where Ље electrical supply is ≡eliaDie.

1Third Pillare Macroeconomic Stability The stability of Ше maσoeco- nomic environment is important for business and, therefore, for the overall competitiveness of a country. Although it is cerf≡ly true that ≡croecono⅛ stability alone cannot mcrease the productivity of a ha■ tio∏∕ it is not less true that macroeconomic disarray harms the econ­ omy. Films cannot make informed decisions when the inflation rate is in she hundreds (typically as a result of public stances being out of contro]). Ehe fiιcxal sector dot function ư the government runs gigantic deficits (especially it as a result, it represses banks and forces them to lend it money atbelow∙market interest rates). The government cannot provide services efficiently if it has to make enormous interest payments on its past debts, ե sum； the economy cannot grow unless Ље тааоелѵкоіеті؛ is stable or favorable. This is why the macro­ economic environment is the third pillar of economic competitiveness.6

Boυrth Pillar Basic Human Capital H≡an capital is tiιe factor of production associated with the human body. We think of it as having ๒ important components. The first is what we could call basic human ¢碎”也ム which consists of the basic requirements for a human body to function and be productive. Chief among these requirements is health♦ The productivity of an τmhealthy human body is less than that of a healthy comterpart آلل€ recent AIDS and malaria pandemics in large region of ⅛e world make it dear that business conlons deteriorate when the health of the population deles⅛ Another component of basic human capital is basic education: literacy and primary schooling have nowadays become essential requirements for competitiveness?

Fifth Pillar: Higher Education and Training ե more advanced economies^ good health and basic education are not enough for citizens

to earn a decant l။g٠ Advanced education (secondary and tertiary schooling) and flexible skills need to be acquired rn high-quality s⅛ob or in the workplace ⅛ugh sophisticated on∣the→ob ⅛ammg□

• The quaπty of the education system, therefore^ and not only its enr0H- ment rates and the quantity of scientists and engineers it yields, plays art essential role in the process of wealth creation for these more advanced forms of human capitals

SÌẾ РШаг: Goods Mắet Efficiency The ®ciency of Me products and services markets is also an important factor rn a nation’s ρroduc∣ tivity٠ Goods market e&aency is needed in at least ⅛ree levels. First, e&cient markets require nondisruptive public interventiorLS (Ŵat is, policies and regdations need to cause as 11tde disruption as possible). Excessive or inefficient taxes, burdensome subsidy policies, or non­ transparent legal systems are some ways in which government actions distort ⅛e markets for goods and services. Second，market ef&ciency is driven by business competition· Competition imposes tiιe necessary discipline and. readiness on fừn٦s so that they operate rn the most ả dent manner. Market domman∣ce by one or a few films tends to gener­ ate market me⅛L⊂encies, as do restrictions to competition from foreign rivals° Third, market áciency depends on demand conditions such as customer sophistication: customers who accept poor treatment by firms tend not to impose the necessary discipline on companies for ®٠ ciency to be achieved in the market.

Sevens Pillar: LaD0r Mäet Eâiaency Many economic analysts (espeady in Europe) emphasize the flexibility of the labor market as a leading deteuninant of competitiveness। The æual complaint is ⅛at tax and transfer systems tend to reduce incentives to work and that reg!11ations impeding the hirmg and bg of workers tend to impose heavy costs on business. Al⅛ou^ we agree wish this view, we think of e^ciency of the labor market in a broader sense that includes not only public actions (taxes, transfers, regtdations, ánd so on), but also private practices. For шріе, labor-employer relations that are very confrontational tend to generate an adverse b^iness en٦٢1r٠ment٠ The systematic promotion of relatives rather than workers wish sup^ rior qualifications, or the payment of wages that are not related to pro- ductivi^/ tend to have perverse e^cts on the productivity of the economy.

Ano⅛ιer labor practice that is harmful to competitiveness is discrimi∙ natio∏∕ of allocating jobs not on the basis of the talent of the candidates.

but instead on Ље basis of ⅛eir racez religion, gender，or similar con- sideration. One of ⅛e most widespread discriminatory practices con- cerns women's labor participation: countries that exclude half of their populations from ⅛ best jobs misallocate half ٠f their talent. This has important consequences for a country's ability to generate prosperity.

Eighth РШаг: Financial Market Efficiency An elicient financial sec- tor is needed to allocate the resources saved by a nation's dtizens to its most productive uses. A proficient Rnancial sertor channels rasouιces to Ü1e best entrepreneurs rather than to the politically corrected. A modem financial sector develops products and m⅛ds so that small innovators with good ideas can implement Љет. A well-ftaictioÉgfi- nancial sector needs to provide risk capital and loans and be trustwor∙ thy and transparent, lh a globalized world, the role of foreign financing is also important, especially for economies with less-developed finan: dal systems. Thus, we include the foreign financing (in the fo≡ of for- eigπ direct πτvestment) in our analysis of financial ≡ket efficiency·

Nmủ Pillai: Technological Readiness One of the central differences between πώ and poor countries is that ոձ countries tend to use more advanced and complex production processes and to produce more so- ρhisticated products and services. In other words, ihey tend to have a superior technological background. Whether the technobgy used has 0【has not been invented within 6ه counựs borders is immaterial for our ршроѕеѕ. The central point is that Ље firms operating rn the country have acc≈s to ⅛ese advanced products and blueprints. That is, it does not matter whether a country has invented electricity, the Internet, or ⅛e airpbe٥ What is important is What եշ inventions are available to the business community.

This does not mean that the process of innovation is irrelevant. However, the level of technology available to fírins in a country needs to be distinguished from the country's ability to innovate and expand ihe frontiers of knowledge. That is why we separate te⅛ological readiness from innovation『 which is the twelfth pillar「to follow.

Tenth РШаг: Market Size The size of the market affects productivity because large markets allow firms to better eφloit economies of scale. Traditionally, ⅛e markets available to firms have been constrajτwd by the borders of the. nation。In the era of globalization/ e>φorts have be- соте a substitute for domestic markets/ especially for small countries.

The empirical evidence on the relation between rnterπational trade and growth is highly controversial. There is a lot of evidence showing that trade is positively associated with growth.9 There is some evi- dence suggesting that these results axe not as strong and convincing as one would Hke, but there is no evidence suggesting that trade and growth are negatively associated. Our reading of the literature is that the relation between opermess and growth is likeły to be positive and robust especially for small countries with smaU domestic m^kets٠ For larger economies, the domestic market may be large enough that no extra gains are achieved by further opening borders to trade. Thus, we think of international trade ad a substitute for domestic demand in determining the size of the m^ket for the firms of the co٦mtry٠ This is partic⅛ly important rn a world rn whi& economic borders are not as clearly delineated as political ones. In other words, when Belgian sells goods to the N6H1erlands, ⅛e national accounts register the ⅛i- action as an export (so the Netherlands is a foreign market of Belgium), but when California sells the same kind of output to Nevada』ü٦e na- tional accounts register the ⅛ansaction as domestic (so Nevada is a do- mestic market of Califomia). By adding domestic and foreign markets in our measuie of market size, we avoid discriminating agarnst geo- graphic areas (such as the Егігореап Union) that are broken into many com±ries but have one common market. This is why we do so when we construct ⅛e tenth ρiUar of economic competitiveness: the market size.

Eleventh РШаг: Business Sophistication Economic development usually requires increasing degrees of business sophisticatioiL One form of sophistication is the formation of clusters⅛ As defined by Porter (2003/ 2004), ^dusters are geographically proximate groups of inter- connected companies, suppliers, service providers, and associated institutions in a particular field, ：ied by colonies and comple- mentaHties." Clusters affect competitiveness in various ways: first fems wiih a cluster have more efficient access to speci⅛ed suppliers, employees, information，and Gaining than do isolated firms՛ and this ⅛eases their productivity. Second, clusters increase the capacity for productivity growth This is because opportunities for innovation are often seen more easily ־within clusters, and because Ü1e sk□ls, assets, and capital required to innovate tend to be more available aιound clusters. The third way ئ. which clusters affect competitiveness is by the fo≡ation of new businesses through the reduction of barriers to

entry (for example, the presence of many experienced workers and access to all the needed іприУ and specialized services within a ρrox- imity makes it easy to set up new firms, which reduces barriers to entry).

A second fonn of business sophistication is through the introduction of more complex operations and strategies. For example, the use of marketing or branding, the utilization of superior distribution systems, the access to advanced technologies, and the introduction of modem business organizational forms are an ingredients in the process of busi- ness modernization (see Porter 2003).

Twelfth РШаг: Innovation The last рШаг of competitiveness is teả- ท๐1๐§1๗ innovation. One of the central tenets of neoclassical growth theory is that/ in the long πm, the only sustainable source of economic prospdty is te⅛ological ρrogress.1° Although substantia] gģ can be obtained by improving institutions, building infrastructures, redu4 mg maaoecononúc instab⅜ or increasing the human capital of the population, all these factors seem to ≡ into eventual diminishing returns, ե same is true for the efficiency of the labor, :financial, or goods markets. In the long run, standards of liv⅛ cannot be eχ. panded without technological innovation. Innovation is particularly important for economies as they approach the sentiers of knowledge and the possibility of copy and imitation tends to disappear The types of environment most inducive to ⅛novation includes modem univer- sities and research institutions that cooperate with businesses, a legal regime that protects intellectual property rights, public institutions that understand the importance of knowledge and act on this under- standing when they make purchasing decisions, and the availability of scientists and engineers who can participate in the process of techno- logical improvement.

Although we describe the twelve pillars of competitiveness sepa- rately, we do so on[y for expository purposes. This should not obscure the fact Mat they ate not independent: not only they are related to each other, but they ako tend to reinforce each other. Aga⅛, innovation (twelfth p⅛) is not possible b٦ a world witih51t institutions (first pÜlar) that guarantee intellectual property rights; it cannot be per- formed in countries with no human capital (fifth pl); and will never take place in economies with inefficient markets (sixth, seventh, and eighth pmars), or ־without infrastructures (second piUar).

Prinâple 2: Stages of Development

The second principle on which the Global Competitiveness Index is -founded is that economic development is a dynamic process of succes ة

sive improvement, in which economies find increasingly sophisticated ways of producing and competing, ե other words, the process of eco- noιnic development evolves in s^0ges.

Many economists in the past have postulated theories of "stages of development." Perhaps the most famous of a□ these theoHes was that of American historian W. W. Rostow.11 Although Rosto־w׳־s theory involves five stages, his was essentially a &eory of industrial- ization through savings and investment. The various stages were phases through which Hιe req٦ửed resources to invest were acc≡u- latea, but successful take off occurred only through physical capital accumulation.

Our view is that the process of growth and development is a lot more implicated than a simple process of investment in physical cap. ital. It involves the successful implementation of policies and instita- tions on many different fronts. How important each factor is depends on the level of development of a particular country: what makes the United States competitive may not be the same as what Ểes Angola competitive because H1ese two countries are in different phases of de- velopment. Thus, we adopt the framework of stages of development to organize the index. This fraÄework is close in spirit to ־that of Forter (1990), although, there are some important discrepancies. One differ- enee is that, while he thinks of the process of development as involving foυι phases, we WÜ1 use only three. Porter's fourth stage of devel- oρment, which he calls the weã-drwen stage, leads to a decljne in standards of living. The economy is driven by alieady-accumulated wealth, which shifts incentives away ⅛om efficient investment and in- novation. Since we do not observe declining growth rates for eco∏o~ mies with the highest leve^ of per capita GDP, we do not include this fourth stage in our analyse. Another difference is that the exact ele- ments ihat are important at ea& stage are not the same. A t⅛d differ- enee is the way Porter sees the second stage as driven by the ability and willingness to invest, while we see it as being driven by efficiency. A fourth difference is m the way countries are classified. But the most important diference is in the exact translation of the concepts to a mea- surable index.

Խ the most basic stage, called kfactor-ârwen stage, firms compete in price. That is, they take advantage of their cheap Actors (including low-cost labor and unprocessed naføral resources). In stage 1, firms produce commodities and simple products originally invented and designed in other countries. Խ order to be competitive at this initial stage, an economy must satisfy some basic requirements. Chief among them are good institutions, suffirent ⅛astruciuresz basic human сарі- tal, macroeconomic stabrnty, and overaU ρersoι1al security. An impor- tant point is that being successful in this stage eventually means losing competitiveness unless economies prepare for ־the next stage. The rea- son is that success&¿ economies e^erience positive growth rates, and this means ■growing wage rates. For a country whose souτce of compet- itiveness is the low price of its labor, a growing s^aιy impHes a loss of competitiveness.

In stage 2, which we call the efficiency-driven stage, efficient produc- tion practices become the ma^n source of competitiveness. The quality of an e8nomy's products 3ot only its prices) and the effectiveness of the production processes determine ⅛e productivity of firms in this stage. To achieve this, nations meed to improve ihe efficiency of their goods markets, labor markets, and financial markets, ^ey ако need to have an improved education and trading system and to have access to ihe best technologies (even if tì^ey need to import them ứom abroad). Because competitiveness at this level is founded on effi_ dency, access to larger markete aUows business to exploit economies ofscale.

Fina□y, in stage 3, which we caU innova^n-đriuen stage, successful economies can no longer empete in price or even quality because 也也 own success has increased prices (especially wages) so much that Whey can no longer compete by producing she same goods. It is time for these economies to produce "different" goods—innovative products and practices vising the most advanced methods of production and organization. In this stage, businesses need to increase their sophisti- cation by organizing in clusters and by opting for advanced and supe- rior operations. Films compete ״with unique strategies. Institutions and incentives supporting innovation become the central part of economic competitiveness.

Of course, each of the twelve pillars of competitiveness outEned т the previous section, matter for every one of she stages of development. The point, however, is that different factors matter d^erenťly for coun- tries in different stages. For example, although the ability to innovate

matters for.a∏ nations, it is undoubtedly more important for advanced countries than for economies in the early stages of development. We, therefore, implement the idea of "stages of development" by giving diferent weights to each of the twelve pillars in each of the three stages. To this end, we group ⅛e рШагѕ that we think are more Ünpor- tant rn the factor-driven stage into what we call basic requireits, Basic requirements include institutions (first pillai), physical Ểastouctures (second piHar), macroeconomic stability (iiυιd рШаї), and basic human

：「capital (fourth pillar). We geup the рШагѕ that are more important in the eBaency-dπven

stage into what we сай efficiency Ểncers. The efficiency enhancers in- elude higher education and tramrng (fifth pffiar), goods market ρffi- ciency (sixth p⅛‰ labor market efficiency (sevenih p⅛), financial market efficiency (eighth pi□ar), technological rea⅛ss-(⅛th ?Шаг), and market size (ten⅛ p≡ar).

FinaUy, we group the pillars that are more important in the innovation∣cLriven stage into what we call İTmovation の以 sophistication ل

∕zcf0%, which indude business sophistication and ^rmovation, our elev- enth and twelfth pillats respectively.

An important practical advantage of framing the process of eco- noỂc development in stages is that it helps countries prioritize the areas in wruch they should focus their attention. By giving more weight to some pillars than to others, the analysis presented rn ⅛ chapter can be used as a tool for countries to pay attention to the p∏- lars that are more important for their stage of development. Countries in stage 1 that score low in innovation or in business sophistication should not worry too much. Countries in stage 2 that are fast ap- proachrng stage 3, on the other hand, should worry about not doing well in these areas.

Constructing the Index Once ⅛e three basic groups aιe defined, the index of competitiveness is constructed as a weighted average of the three groups. In other words,

ca = α、لا ՜basic requirements キ Աշ X egįciency enhancers

аз × innovation and sophistication factors ب (1∙1)

where a!, &2, and %3 are ẁe weights that each subindex gets in the overall index. 12

Table 1٠1 Stages of development

Newshares

Basic reqι1kemeπts Efficiency enhancers ]⅛1ovation and sophistication factors

Stage ] Stage 2 Stage 3

0.6 035 0.05

C4

0.5 0.1

0.2 0.5 0.3

The idea behind, the concept of stages of development is that all com- ponents matter in a□ stages, but some matter more than others in dif־ ferent stages, ե other words, the weights (a in equation 1.1) that each subindex gets rn the overa□ GCI depend on ⅛e stage of a particular country. The exact weights of each of the three groups are displayed in table 1⅜1∣ h stage 1, the basic requiremus have a weight of 60 percent, the efficiency enhances have a weight of 35 percent, and the innovo- tion ard sophistication factors have a รฟ weight of 5 percent.

In stage 2, the weights of the basic requirements and the efficiency enhancers are 40 and 50 percent respectively, while the weight of the innovation and sophistication factors is 10 percent.

Finally, ئ. ӥге rnnovation-driven stage, the weight of the basic re- quirements fall to 20 percent, the weight of the efficiency enhancers stays at 50 percent, while that of the innovation and sophistication fac- tors increases to 30 percent.

Principle 3: Transitions

Ehe third principle on which ⅛e new Ga index is founded is thatz as economies develop, ⅛ey move from one stage to the next in a smooth fashion rather than in abrupt jumps. Thus, the weights of each of the subrndexes (shown as a in equation 1.1), change smoothly as a country develops. This means that we have five groups of countries: the three groups ■that belong to the three stages previously described, ?๒ the countries that are moving ứom stage 1 to stage 2 plus those that are moving from stage 2 to stage 3.

One advantage of allowing for the weights of each subsmponent to change smoothly abng the transition is that countries that do not pre- pare for more advanced phases of development as they grow out of stage 1 into stage 2 get penalized. We think that countries that do not adapt iheir economic environments to ihe new stages tend to lose com- petitiveness. The season is that wages tend to increase in economies

that grow. Thus, countries that grow from the factor-dιiven stage to the efficiency-driven stage tend to юзе Eeir abrnty to compete in prices and low costs. In o⅛er words, as e∞nomies in stage 1 grow, ⅛ey s9wly lose their comρeιiiiveness. A good index of competitiveness, therefore, must capture ü٦is phenomenon and must therefore partly penalize economies that, while approachjng stage 2, do not ρrq5are for the challenges involved rn this more sophisticated phase of eco- noÉ development. Our index has this property because for countries ⅛at do not adapt to ťhe more advanced phases, the values of the efS- ciency enhancers tend to be lower than the values of the basic require- ments. By smoothly reducing the weights of ⅛e basic requirements and increasing those of ⅛e efficiency enhancers, we tend to lower Ше overaU value of the index for those countries as their e8nomy grows.

Wedo a similar thing for economies that move along the transition from stage 2 to stage 3.

Final Thoughts

The World Economic Forum's Global Competitiveness Index is a use- f⅛ιl way to organize the results of the WEF's Executive Opinion Sur- veys. Although on publication of each year׳s results the popular press puts aU the emphasis on ti٦e relative τank⅛gs, we Ъйіеѵе that 出6 data usea m constructing the index can be used by policymakers to priori- ∙ tize policies and reforms. After all, when fig in the surveys execu- tive oncers are implicitiy ranking the various aspects of the economy in which they operate. One therefore can use ÜÜS implicit Tanking of subcomponents as &e opπuon of ־the business community on ־what it believes are the bottlenecks of a particular country.

Notes

1٠ See Acemoglu, Johnson, and Robinson 2002,2Ọ02; Barro and S≡⅛-i-I⅛tin 2992,2D03; Kodrik, Subramanian, and Trebbi 2002; Easterly and Levine 1997; and Sala-i-Martin and Subramanian 2003.

2∙ See De Soto 1990 for an Üluminating analysis of how bureaucracy harms growth

3. See Shleifer and Vishny 1997 for a comprehensive survey of corporate governance and the firm. See a⅛o Zing^es 1998.

4. World Bank 2004; Grämlich 1994; Aschauer 1989; and Canning, Fay, and Perotti 1994.

5. Easterly 2002 explains how important Ље World Bank has usuaUy thought physical infras⅛cħ1res are for ±e process of economic development.

6. See Sala-i-ỉvíartín, Doρρ⅛fier, and ier 2004٠

7. See Sachs 2001 for а comprehensive review of how hea½ afecte the econome pros- perityofMtid

8. See Sch111^ 1961; Becker 1993; and Lucas 2988.

9. See Frenkel and Romer 1999; Rodrik and Rodriguez 1999; and Sachs ฟ Warner 19951

10. See Solow 1956; Swan 1956; Romer 1990; Aghion and Howitt 1992; ๗ Grossman and Helpman 1991.

11٠ See Rostow 1960.

12. Since these are weights, M coefEcients a!, ئی, and 03 are required to add up to 1.

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2 Competitiveness, Economic Performance, and Structural Polices: An OECD Perspective

Jean-Philippe Cotis, Alain de Serres, and Romain Duval

2.1 Introduction

The world is obsessed with competitiveness. Conferences are heid to discuss competitiveness. Polìtìâans ■emphasise competitiveness. Major

:[policy Ểatives, such as the Lisbon Agenda in Ешоре, are launched ;with reference to competitiveness. Yet, the focus on competitiveness ]makes little sense for a discussion of econoÉ pohdes. At face value,

the notion of competitiveness as a policy objective has a mercantilist -flavor. It is suggestive of a 2ero-s≡ game wh8eas, rn fact, one coun- tryzs economic success rarely hampers, and &equenÜy benefits, that of other countries. A focus on competitiveness may thus lead to counter- productive policy reactions. It is easy to imagine an "armaments race" as countries try to improve or preserve perceived competitiveness, for example by ramping up subsidies for certain activities ·or by protecting "strategic" industries from foreign competition snd investment. Every- one may ultimately lose in such a noncooperative, negative-sum game,

.even though the competitiveness obsession may also bģg benefits, -such as forcing countries into needed structural reforms. :Even abstracting from the possibility ỉhat othercountŗies may react,

·improving external cornpetitiveness is no recipe for improved eco- nomic performance. Germany and. to a lesser extent Japan have been

[prime examples for most of the past decade, with their combination of 「low growth and strong extemai competitiveness. In order to provide a meaxυngftd policy discussion, while st≡ vising the c-word in the title, we will therefore interpret the concept of competitiveness in a much

[broader sense. More specificaUy, we think of competitiveness as a gauge of the extent to which policies create the right enviromnent for 〔output maximization.