Competitiveness – no problem!

 

As always there is a lot to look out for in the macroeconomy but being inside the Eurozone implies that the government budget and external competitiveness are of particular concern. In terms of the former, the (relatively) new Fiscal Discipline Law and the newly established Fiscal Council have been created. 

No particular body exists to monitor external competitiveness (and I am not sure how such a body should be formed anyway) but it is certainly monitored after all by the central bank, by the commercial bank economists, by the EU and by some of us independent economists with an interest in the topic.

A typical first place to look is the real effective exchange rate (REER), roughly speaking a measure of cost developments in a country compared to cost developments in trading partner countries adjusted for exchange rate developments. My preferred measure uses unit labour costs i.e. the development in costs per unit of production and I have plotted the development in five countries around the Baltic Sea since 2005 in Figure 1. The three Baltic countries, Germany because of its relentless focus on cost competitiveness in the past many years and Sweden – big trading partner and one with a flexible exchange rate.

Figure 1: Real Effective Exchange Rate, REER, the Baltics, Sweden and Germany, 2005 – 2013, 2005 = 100. Unit labour costs, 37 trading partners

Source: Eurostat

For those familiar with REER, it tells the well-known story of Latvian external competitiveness being lost during the boom period when costs exploded here due to massive wage increases, resulting in high inflation. Since the crisis a good chunk of lost competitiveness has been regained via wage decreases and/or productivity increases above wage increases – why not start referring them to ‘internal devaluation’ and ‘internal devaluation light’ to distinguish the two types? But whatever the reason (which is not the issue here) competitiveness has been regained but not fully, i.e. not with REER back to its 2005 level. Is that a problem? REER is an index so it tracks developments in competitiveness, not the actual stance of competitiveness, which is much harder to assess.

But an indicator of that there actually is no competitiveness problem to speak of is provided in Figure 2.

Figure 2: Share of exports in GDP, the Baltics, 2000 – 2012

Source: Eurostat

Figure 2 shows the development of export as a share of GDP since 2000. As can be seen this jumped during and after the crisis to levels never seen before in Latvia (though to even higher levels in Estonia and in Lithuania); roughly from 40% to 60% of GDP, also implying levels of exports that have never been reached before here, hardly indicative of a competitiveness problem.

So no need to worry but of course good reason to keep tracking the development.

But on a final note, my personal point of view is that a country that sells residence permits in exchange for property investments is without a proper business plan and perhaps not all that competitive after all….

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga