EU wanes in competitiveness

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If the nations of the union follow divergent growth paths in the future, it will lead to tensions among the economies

Competitiveness ma-tters considerably for national prosperity. For many years, the EU has been concerned with the competitiveness performance of its member states and has accordingly devised a number of strategies to improve it. In 2000, the EU launched the Lisbon Strategy, aimed at making Europe “the most competitive and dynamic knowledge-based economy” by 2010. It was a vain attempt. The strategy was criticised in retrospect for being too broad, covering too many issues and lacking a compliance mechanism to give the recommendations teeth.

Having recognised that they had not met their goals, European leaders in 2010 conceived a new competitiveness plan, the Europe 2020 Strategy, with the purpose of encouraging national and regional policies that could provide growth and jobs in the coming decade. It aimed to achieve innovation-driven, sustainable and inclusive growth. But much of the original good intent has since been side-tracked by the short-term firefighting of the financial and sovereign debt crises, which has prevented policy-makers from focusing on and investing in the measures needed to boost European competitiveness.

But what does competitiveness actually mean? The global competitiveness reports of the World Economic Forum define competitiveness as “the set of institutions, policies and factors that determine the level of productivity of a country.” The level of productivity, in turn, determines the level of prosperity that can be achieved by a particular country. The productivity level also determines the rates of return obtained by investments in an economy, which are the fundamental drivers of its growth rates. Simply put, a more competitive economy is one that is likely to provide high and rising living standards over time.

What are the key drivers of productivity and competitiveness? The main vehicle used by the World Economic Forum to measure competitiveness is the global competitiveness index (GCI). The GCI is made up of 12 pillars of competitiveness. These range from the basic to the more complex and include political institutions and governance, infrastructure, macroeconomic stability, health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication and innovation. Variables measuring each of these concepts are combined to come up with an aggregate score on a scale of one to seven, with seven being the best possible outcome. The latest Global Competitiveness Report covered 144 economies.

On average, Europe trails other advanced economies in the creation of a smart, highly productive economy. This has had consequences on the region’s prosperity level. Indeed, the gap in terms of income per capita has widened between the EU27 economies and the highly innovative and productive United States over the past two decades. And while the 27 countries on an average were significantly wealthier than the Republic of Korea in 1992, they have been overtaken by it since the beginning of this decade as South Korea has seen a significant improvement in its productivity and competitiveness.

In large part, the widening income gap between Europe and some of the more competitive econ-omies can be explained by a competitiveness deficit. When compared with the United States across several of these pillars, although the EU fares somewhat better on average in terms of its macroeconomic environment, it trails behind the United States in many other areas, most notably in the efficiency of its labour markets and its capacity to innovate.

A major issue for the euro zone is that a significant gap also exists among EU member states: some countries perform very well across the different pillars that determine competitiveness, while others do not. The Global Competitiveness Report 2012-2013 shows convincingly that countries with relatively high levels of economic prosperity but that lag in building a knowledge-based, highly-productive economy are those that have suffered the highest losses in terms of employment, salaries or both. In other words, high levels of prosperity in Europe cannot be sustained over time without high levels of competitiveness.

In terms of competitiveness gap, significant disparities in terms of performances exist across the continent. They range from the very strong performances of countries such as Finland, Germany, the Netherlands and Sweden, ranked at the top, to the poor and declining performance of Greece, ranked a low 96th out of 144 economies. More generally, the northern European countries are the most competitive and southern, central and eastern European countries the least competitive.

To understand the areas driving this diverging performance, the performance across the competitiveness pillars was compared between the northern and southern European economies.

The divide between northern and southern Europe is significant across almost all areas. As well as macroeconomic stability, northern Europe receives a much stronger assessment for the quality of its institutional environment, the efficiency of markets, its propensity for technological adoption and innovation, among others. These significant differences, of course, constitute a serious problem when countries are bound by a common currency.

Nations will follow divergent growth paths in the future, creating tensions among economies. At some stage, competitiveness and economic growth will have to converge between northern and southern Europe if the monetary arrangement is to survive.

A question remains as to the future path of France, a country with a less than-stellar competitiveness profile. Ranked 21st, France trails the most competitive economies of northern Europe by a significant margin, despite a number of clear strengths, particularly related to the country’s excellent human capital base and propensity for technological adoption. Yet businesses in the country are saddled with an extremely rigid labour market and an often difficult regulatory environment. Amid discussions now taking place about the country’s economic future, one wonders whether France will become more “northern” or more “Mediterranean”, even as the Mediterranean euro zone countries to its south strive to address these issues.

Amid the current euro zone difficulties, inevitably the question also arises as to how the single currency relates to competitiveness. Could some countries have done better in terms of competitiveness by being outside rather than inside the euro zone?

This is doubtful. Sharing a common currency prevents the external adjustment that a country can achieve by devaluing its currency, but this export-led recovery idea corresponds to a very narrow and mechanical definition of competitiveness, one that equates competitiveness with an improvement in the current-account position, which does not necessarily lead to longer-term growth.

Many industries in Europe rely to a significant extent on inputs from other countries, so the rising price of imports will undermine their competitive positioning on international markets. Moreover, the depreciation of a currency makes the citizens of the country poorer because it leads to an increase in prices of imports and therefore a decrease in real incomes, similar to a collective national pay cut when viewed from an international perspective.

As has already been seen among EU countries, divergent income levels and growth rates are to a very significant extent the result of differences in competitiveness and productivity, the underlying factors of which are much broader.

Indeed, some countries, such as Germany and the Netherlands, responded well to the incentives and discipline imposed by a single currency and succeeded in improving their economic performance. Others that took advantage of low interest rates to increase debt to finance unproductive investments did not do so well.

Would Greece, Italy, Portugal or Spain have fared significantly better outside the euro zone? Probably not, because without far-reaching structural reforms, they would have failed to prosper, no matter what.

These results in terms of divergence point to the complexity and difficulties of bridging the competitiveness divides in Europe and raise questions about the sustainability of the income convergence that many European economies have experienced in recent decades. The recent declines in income in previously converging econ­omies, such as Greece, Portugal and Spain, where an important competitiveness divide persists, suggest that stable economic convergence may only be possible if decisive action to address the weaknesses in the competitiveness of these countries is taken.

Only by improving the competitiveness of the countries that are trailing and narrowing the competitiveness gap will Europe find a sustainable exit to the sovereign debt crisis and place the euro zone and the EU more generally on a path to more sustainable growth and employment.

(The author is the founder and executive chairman of World Economic Forum. This article was excerpted from an e-book titled, The Re-emergence of Europe)

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