UK: BE MORE COMPETITIVE BUT FOCUS MOST ON PRODUCTIVITY. - We need to boost growth in all sectors, not just those where we compete most.

by David Smith.
Last Updated: 31 Aug 2010

We need to boost growth in all sectors, not just those where we compete most.

Competitiveness has been one of the hot economic topics of the year. In May, the Department of Trade and Industry published a White Paper devoted to the subject, underlining the Government's view of its importance.

In Europe, the debate has been on how the high-wage, advanced industrial nations can compete with the low-wage, newly industrialised countries of the Far East, including the emergent Chinese economy. America has skirted dangerously close to a trade war with Japan, based on the argument that if there is nothing wrong with the competitiveness of US products, the fault must lie with unfair trade practices.

The DTI White Paper took us over familiar ground. Britain needs a better education system, so that industry can compete on level terms with foreign competitors. Its anti-industrial culture needs to be tackled. New product development must be given higher priority. There must be more spending on R and D and closer links between academic and business life, ensuring the speedy commercial application of new discoveries.

All laudable aims, but the competitiveness debate raises as many questions as it answers. Why does the financial services sector, generally acknowledged as internationally competitive, thrive when it takes its new talent from the same education pool as industry? Is the anti-industrial culture merely another way of saying that people have recognised that the financial rewards available in other parts of the economy are greater than those in manufacturing and are responding rationally to such signals?

Why are some UK companies capable of taking on, and beating, the world's best, while others struggle? And why, if British industry is now highly-competitive in relation to German industry, does Britain run a trade deficit with Germany running to several billion pounds a year?

The argument over competitiveness in Britain goes in cycles. In the second half of the 1980s, during the Lawson-Thatcher 'productivity miracle', British industry was claimed to have made such strides that it could take on overseas competitors with ease. Such optimism soon faded, but it was back again after sterling's departure from the European exchange rate mechanism in September 1992, which gave industry a competitive boost that would have taken years to achieve by means of superior productivity growth. Britain, as the chart shows, is competitive in relation to Europe and Japan, but not relative to America or the newly industrialised countries of the Far East.

The competitiveness debate is also caught up in another long-standing question - whether Britain has a manufacturing base large enough for the size of the economy. The two are linked, but one is concerned with quality, the other with quantity. Is it better to have a small, highly competitive manufacturing sector, or a large, less competitive one?

Indeed, the American economist, Paul Krugman, argues that 'the whole concept of competitiveness is at best problematic, at worst misleading'. In a new book, Peddling Prosperity, Krugman argues that productivity and competitiveness have become entangled in a potentially dangerous way.

The increase in a country's long-term standard of living is dependent, not on competitiveness, but on productivity growth. This is what matters, he writes, not America's productivity growth in relation to Japan or other countries. But surely a country with an inferior productivity growth will price itself out of world markets with dire consequences for the economy?

Not so, says Krugman. A country with an inferior productivity record simply needs to ensure that it depreciates its currency to compensate for it. This idea, incidentally, has an honourable tradition going back to Milton Friedman and James Meade in the '50s, who argued that it was better to adjust the exchange rate to achieve balance of payments equilibrium, rather than painstakingly try to change all the other prices in the economy.

Is this not, however, the old failed remedy of trying to devalue your way out of trouble, at a cost to the standard of living of your citizens? Krugman demonstrates that if US productivity growth is 2% a year below that of the rest of the world then a 2% annual depreciation of the dollar will be the painless solution. The standard of living of American citizens does not suffer from higher import prices, because the 2% depreciation exactly offsets the 2% price reduction that imports would otherwise undergo as a result of the superior productivity performance of foreigners. My only quarrel with his prescription is that in the real world it is rarely possible to achieve controlled currency depreciations of this type.

Krugman's argument has a practical point, however. Its first target is the Clinton administration, which is dominated by 'strategic traders', those who believe that competitiveness is not a problem for US industry, but opening-up foreign markets is. The more the trade rhetoric moves in this way, the greater the risk of trade disputes that would be damaging for all.

The second target is the argument that 'competing sectors' of the economy need to be given special treatment. In other words, it is vital to raise productivity performance in manufacturing because that is the part of the US economy which trades most with the rest of the world. But, as far as the standard of living is concerned, it would be far better to focus on raising productivity growth in the services sector. Each percentage point rise in services sector productivity would produce three-and-a-half times the standard of living gains as a corresponding rise in manufacturing productivity. 'Ultimately the rhetoric of competitiveness will be destructive because it can all too easily lead both to bad policies and to a neglect of the real issues,' says Krugman.

Both arguments have their parallels here. Earlier this year the EC imposed quotas on certain imports, notably toys and silk from China, following a decision (opposed by Britain) by European trade ministers. They had been introduced, according to the Commission official responsible for overseeing the quotas, because Chinese prices were 'too low'. This was discrimination against a country because it happened to be highly competitive - protectionism of the worst sort.

The other argument, that special attention has to be given to raising manufacturing productivity, had echoes in the DTI White Paper. Again, there is a long history. The Wilson government's selective employment tax of the 1960s, which operated against service industries, was an example. Raising manufacturing productivity is a desirable aim, but not if it is done at the expense of other sectors. The 'special case' argument for manufacturing, bound up as it is with the argument over competitiveness, is an intellectual dead-end. The way to improve the UK standard of living is to boost productivity growth in all sectors not just those in which we happen to compete most with other countries. An obsession with competitiveness could take us down the wrong road.

David Smith is economics editor of the Sunday Times.

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