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Asian Development Outlook 2003 : III. Competitiveness in Developing Asia
Aggregate Measures of CompetitivenessAlthough the idea of competitiveness, understood as the capacity to compete with rivals, does not fit in well in terms of countries, at the national level, economists use several indicators (apart from labor productivity) that are referred to as measures of national competitiveness. First, national competitiveness has been used to mean labor productivity. This is coherent with the argument that the key variable to achieve long-run growth is productivity. However, if productivity is used to measure competitiveness, then the term national competitiveness is simply "a poetic way of saying productivity without actually implying that international competition has anything to do with it" (Krugman 1996a, p.10). Second, national competitiveness has been used to mean price competitiveness (Hooper and Larin 1989, Durand et al. 1992, McCombie and Thirlwall 1994, Turner and Golub 1997, Turner and Van 't dack 1993). The most widely used and well-known measures are the real effective exchange rate (REER) and unit labor cost (ULC).4 It is this view of "competitiveness," i.e., price competitiveness, that people often have in mind when making general statements about a country's competitiveness. From this perspective, it is correct to refer to the PRC as being competitive at the moment. The PRC's currency is undervalued, its wage rate is lower than that in many countries in Southeast Asia, and its labor productivity is about the same or higher. Hence, its products are competitive in terms of the REER and ULC. For empirical purposes, however, there are several problems with the REER and ULC. First, obtaining reliable data on wages and productivity to construct ULCs, especially for developing countries, is not easy. Second, a problem concerning intercountry comparisons of ULCs is how to translate the costs calculated for individual countries into comparable or common-currency units. Third, a rise in a country's ULC relative to that in other countries should lead to a decline in its competitiveness, which would translate into a lower global market share. However, empirical evidence has shown that, over the long term, market share for exports and relative unit costs or prices, of industrial countries especially, tend to move together—the "Kaldor paradox" (McCombie and Thirlwall 1994, Fagerberg 1996).5 Likewise, it is clear from the historical evidence that the substantial exchange rate movements that have taken place since the early 1970s have not rectified balance-of-payments disequilibria. Speculative capital flows, rather than changes in economic fundamentals, have often driven these movements. Fourth, a rise in either the REER or ULC can be accompanied by strong economic performance. For example, if firms in a country become more successful in terms of non-price competitiveness because they are innovative, flexible, produce high-quality goods, etc., then the REER would probably strengthen. Finally, both measures can be calculated in different ways, thus potentially leading to different results. From a policy perspective and in pursuit of overall competitiveness, some economies may become price competitive by keeping their currencies undervalued through nominal depreciations. For short periods of time there can be important gains in price competitiveness due to exchange rate fluctuations, largely resulting from short-term speculative capital flows. These exchange rate changes are much more volatile than productivity. The result is that there can be sudden dramatic changes in price competitiveness without any change in the fundamentals. A strategy of keeping a currency undervalued, however, will most likely be unsuccessful in the long run since it may only mask and perpetuate a lack of productivity in the country's firms. It may also lead to competitive devaluations and beggar-thy-neighbor trade policies (UNIDO 2002, Box 6.3). Countries that systematically rely on devaluations to maintain competitiveness often fail to pay appropriate heed to quality and innovation. Other economists have used Balassa's index of revealed comparative advantage (Drysdale 1988), defined as the share of a commodity group in the economy's total exports, divided by that commodity's share of world exports, so that the higher the ratio is above (below) unity, the stronger (weaker) that economy's comparative advantage in that commodity group, provided that government policies have not grossly distorted the composition of exports. There is finally, another way of examining national competitiveness based on the construction of composite indices. In fact, the popularity of the idea of international competitiveness has been enhanced by the construction of a competitiveness index by the World Economic Forum (WEF), which is published in the Global Competitiveness Report. The 2001-2002 Report encompasses 75 countries, among them 13 in the Asia-Pacific region. It produces two indices, the growth competitiveness index (GCI), and the current competitiveness index (CCI). The GCI aims to measure the capacity of the national economy to achieve sustained economic growth over the medium term (Table 3.1). It looks at the macroeconomic sources of GDP per capita growth, and generates predictions of the ability of a country to improve its per capita income over time.  The GCI is made up of three factors, namely technological capacity, quality of public institutions, and quality of macroeconomic environment. In each of these three factors, the Global Competitiveness Report constructs indices based on a combination of objective information and opinions of business leaders based on surveys (around 4,600 respondents). The CCI, on the other hand, examines the microeconomic bases of a nation's GDP per capita and provides insights into the level of GDP per capita that is sustainable in the long term. The CCI is made up of two subindices, the quality of the national business environment and the degree of company sophistication (Table 3.2). The data used come primarily from a survey of senior business leaders and government officials. To compute an overall measure of the CCI, all the individual dimensions are combined using common factor analysis.  The CCI is largely based on Michael Porter's (1990) framework, known as the "competitiveness diamond," where the idea of competitive advantages—as opposed to comparative advantage—is introduced. These arise from firm-level efforts to develop new products, make improvements, develop better brands or delivery methods and so on, in other words, to innovate in a broad sense of the term. Innovation, in turn, is influenced by conditions given by four elements of the diamond: factor conditions, demand conditions, related and supporting industries, and the context for firm strategy and rivalry. Although the rankings provided by the WEF are widely cited in some circles, and are taken seriously by some governments, they have been questioned by many academic economists. In a recent paper, Lall (2001a) has put forward a very serious critique of the two indices constructed by the WEF on the basis that it takes an oversimplified view of the constraints to structural change in developing countries. For example, Porter does not provide a theory of competitive advantage in economic terms. The discussion only gives a post hoc explanation, and, even then, in a rather general way, why certain activities have succeeded in certain countries. The link from competitive advantages at the firm level, where the approach is most useful, to the national level remains weak and unsubstantiated. Lall also points out that the indices are atheoretical as the "underlying model tends to lack rigor and clarity, with a propensity to use a large number of variables without theoretically justifying their causal relations to the dependent (and often without measuring them correctly)." Likewise, the weights applied to construct the indices are arbitrary, and the indices display an overly negative view of the role of government (Lall 2001a, p.1506) (e.g., free markets are good and positive for competitiveness while union power or pension benefits are bad). Finally, they rely extensively on qualitative data obtained through questionnaires that are, at most, only tenuously related to the notion of competitiveness. Lall (2001a, p.1507) concludes: "Appealing as all this may be to the Global Competitiveness Report's corporate audience, the economic validity of many of these propositions is debatable." The Industrial Development Report 2002/2003 of the United Nations Industrial Development Organization (UNIDO 2002) introduces a scoreboard in accordance with Lall's (2001a, 2001b) philosophy, and thus differs from the WEF indices. This scoreboard provides important information on crucial aspects of industrial development and competitiveness. It has two parts: an index of a country's ability to produce and export manufactures, the competitive industrial performance index (CPI), and benchmarks of the structural drivers on industrial performance. The CPI measures the ability of countries to produce and export manufactures competitively. It is constructed from four indicators: manufacturing value added per capita, manufactured exports per capita, share of medium and high-technology products in manufacturing value added, and share of medium- and high-technology products in manufactured exports. The first two indicators provide information about industrial capacity, while the other two reflect technological complexity and industrial upgrading of a country. The index is constructed as the average of the four indicators, and is calculated for a total of 87 economies with values for 1985 and 1998, including 14 Asia-Pacific economies (Table 3.3).  Industrial performance, on the other hand, is the outcome of many social, political, and economic factors interacting in complex and dynamic ways. The purpose is to benchmark economies on their key structural variables, called drivers. UNIDO focuses on five proxy variables: skills, technological effort, inward FDI, royalty and technical payments abroad, and modern infrastructure (Tables 3.4 and 3.5). UNIDO's work has the important advantage with respect to the WEF indices that it is much more simple. Likewise, all the variables considered by UNIDO's CPI and drivers, unlike many of the variables that constitute the WEF indices, are very appropriate. The major drawback in the UNIDO approach is also the aggregation of these four indicators into a composite number via a simple average, namely, the CPI. While the individual components of the index convey important information, their ad hoc weights in a single number can lead to a dubious ranking of countries, which is dependent on the exact weights chosen. Consequently, it is difficult to determine unambiguously the implications of such an index.   Summing up, these indices must be treated with caution. Much of the information provided in these reports through the individual variables (such as about innovation capacity) used to construct the indices can be very valuable for purposes of, for example, establishing priorities and policy responses. The Government of Singapore, for example, posts the results of the rankings in its web site (www.psb.gov.sg) and, for policy purposes, it focuses on those areas where it ranks poorly, and outlines steps to address these weaknesses. Nevertheless, as has been seen, the usefulness of the indices themselves is rather limited.
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