Competitiveness, Dani Rodrik Edition

Ever since I discussed Germany’s „competitiveness“, I have been wondering what a proper definition of that term might be. Paul Krugman and others have criticised the standard notion – measures of relative costs and prices – as misguided. Countries don’t compete in the sense that firms do. The current account surplus of a country is probably the worst possible measure, as I have explained for the German case. I therefore suggested a definition of competitiveness as „wages being at market-clearing levels“, but surely this definition doesn’t capture the whole concept.

Karl Smith offers a critique of Krugman et al:

[A]ll of these critiques hinge on a false premise. That it is just as good for us to have capital in the US as to have capital in China. That it is just as good to have the smartest minds and the best Entrepreneurs in the US as it is to have them in South Korea.

This is wrong. …

Put quite simply, it is much better to be in a rich country than in a poor country and resources are in fact scarce. That other countries attract capital and talent will necessarily mean that the US does not.

Some people become confused on this because they forget that countries matter, that joint equity exists and in a very real sense you are in it with your fellow Americans.

Even though the quantity of „talent“ and „capital“ is not fixed, I agree that domestic economic growth and the ability to generate and sustain it should be part of a comprehensive definition of competitiveness.

This made me think of Dani Rodik’s notion of Growth Diagnostics. In a nutshell, Dani’s argument is that there are always multiple constraints on growth in an economy. Removing all of them is impossible, and because of second-best interactions removing some of them might even be harmful, or at least not beneficial. Moreover, removing constraints is always politically costly.

Combining these insights provides a rule for economic growth policy: a country should remove only the most binding constraint(s). Identifying these most binding constraints is far from easy, and the framework that Dani offers provides only a roadmap on how „to confront those difficulties in a systematic way“. Essentially, you go through this process from top to bottom:

If a country’s „competitiveness“ encompasses full employment and economic growth, we could use Dani’s framework to define it. So my suggested definition would then be:

Competitiveness is the institutional ability of a country to constantly overcome binding constraints on growth.

Unemployment is most likely not a characteristic of such a country, so wages will be at market clearing levels (even though extreme cases with unemployment might exist). Paul’s criticism is also included as „competing against other countries“ is part of this definition only insofar as attracting investment and talents is a binding constraint on growth. This also neatly nests Karl’s arguments.

Is such a definition enough to prevent people from using „competitiveness“ in the wrong context? I doubt it. But if economists can agree on a definition, it will be easier to explain why competitiveness of countries is such a difficult and somewhat dangerous concept.

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