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Christine Lagarde, comparative advantage and competitiveness.

by seb.so on 06 May. 2010 01:06 During the lecture on April 19th, Prof. Kirstein asserted that the statement issued by Mrs. Lagarde[1] is inherently nonsensical, as the term ‘competitiveness‘ cannot be applied to a whole country. Assuming I followed his argument correctly, Prof. Kirstein used the concept of ‘comparative advantage‘ to support this point, arguing that a country cannot be ‘more competitive‘ as a whole, since it cannot have a comparative advantage in the production of all products. I would like to question the validity of this argument, as I think it is based on an overly narrow definition of the term ‘competitiveness‘, which in this context cannot be applied. Prof. Kirstein used the term as it refers to the concept of comparative advantage, which is certainly a valid usage. However, it is not the only way in which ‘competitiveness‘ is used. In politics as well as in international business and economics, the term ‘competitiveness‘ is commonly used to describe the overall investment situation offered by a given country. For example, the World Economic Forum publishes an annual ‘Global Competitiveness Report‘[2], which ranks countries by the favourability of their economic environment for businesses. (In this report, Germany usually scores better marks than France, which might help to explain why Mrs. Lagarde is complaining about Germany being ‘more competitive‘.) It is also used in a popular framework developed by Porter[3], who names the four factors ‘factor endowments‘, ‘demand conditions‘, ‘related and supporting industries‘, and ‘business strategy, structure and rivalry‘ as determinants of the ‘competitiveness of a nation‘ as a target for international business activity. To understand why this broader definition of ‘competitiveness‘ makes sense on a global scale, consider a fictional scenario with two countries A and B, which have different labour costs (with labour being the only factor of production) for producing products Y and Z. A: 3€ for product Y, 2€ for product Z. B: 10€ for product Y, 12€ for product Z. In a standard Ricardian model, A would (of course depending on preferences and the terms of trade) produce Z, and B would produce Y. The absolute advantage country A has in both goods does not matter in this case, as only the comparative advantage has to be considered. In the case of Germany and France we have a similar situation, with Germany being country A and France as country B. However, the Ricardian model cannot be applied here, as its assumptions are not satisfied - most notably, there is unused production capacity (potential labour in the form of unemployment), and the two countries are not the only trade partners. Thus, a global company wanting to produce products Y and Z would choose to produce both goods in Germany, raising unemployment in France and increasing German exports. There simply is no ‘produce either Y or Z‘ when there is an abundant labour supply and a host of global export opportunities. Of course, this does not mean that Mrs. Lagarde‘s statement regarding the sustainability of this economic situation is in any way valid (except perhaps in the way that any positive economic growth is unsustainable in the very long run). But I think it does mean that the concept of ‘comparative advantage‘ should not be used to argue against her position. ------------- [1] See Lecture Slides, p.19. [2] See http://www.weforum.org/en/initiatives/gcp/Global%20Competitiveness%20Report/ [3] See http://hbr.org/1990/03/the-competitive-advantage-of-nations/ar/1 Web search, Forum search for Christine Lagarde comparative ...