Edexcel A-Level Economics · Revision notes

4.1.9 International competitiveness

International competitiveness is a country's ability to sell its goods and services in world markets, against products from other countries, both abroad and at home. A competitive economy wins export orders and holds its own against imports. An uncompetitive one loses market share, jobs and income to its rivals. This topic covers how competitiveness is measured, what drives it and why it matters.

Measures of international competitiveness

Relative unit labour costs

Unit labour cost is the labour cost of producing one unit of output:

Unit labour cost = total labour costs ÷ total output

For example, if a firm pays its workers £600 a week in total and they produce 200 units, the unit labour cost is £3.

Key idea: Unit labour costs depend on both wages and productivity. They rise if wages rise faster than productivity, and fall if productivity rises faster than wages. A country with high wages can still be competitive if its workers are productive enough.

Relative unit labour costs compare a country's unit labour costs with those of its trading partners, converted into a common currency. If UK unit labour costs rise faster than those of other countries, UK firms become less competitive.

Relative export prices

This measure compares the prices of a country's exports with those of its competitors' exports, again in a common currency. It is usually expressed as an index. A rise means the country's exports are becoming more expensive relative to its rivals', so it is losing price competitiveness.

Both measures are affected by the exchange rate. A fall in the pound lowers UK unit labour costs and export prices when measured in foreign currencies, even if nothing has changed inside the UK.

Factors influencing international competitiveness

Price factors

• Exchange rates. A lower exchange rate makes exports cheaper abroad and improves price competitiveness, at least in the short run. But a depreciation also raises the price of imported raw materials and components, which pushes up costs and can erode the gain over time.
• Wage costs. Lower wages reduce production costs, though this is not a sustainable route for a high-income economy. What matters is unit labour costs: high wages are affordable if productivity is high enough to match them.
• Productivity. Higher output per worker lowers unit costs. Productivity depends on skills, capital investment, technology and management. UK productivity has lagged behind that of the USA, Germany and France since the 2008 financial crisis, which has held back its price competitiveness.
• Regulation and taxation. Burdensome regulation and high business taxes raise costs, while a simpler system can lower them. Low corporation tax can also attract multinational firms looking for a base from which to export, as Ireland has shown.
• Infrastructure. Good transport, energy and digital networks reduce firms' costs and delivery times. Congested roads, slow broadband or unreliable energy supplies add to costs for every firm in the economy, not just exporters.

Non-price factors

• Quality and reliability of products. Buyers will pay more for goods they trust to work and last, so price matters less to them.
• Design and innovation, often driven by research and development. New or better products can create markets where a firm faces little competition, as in advanced pharmaceuticals or aerospace.
• Brand reputation and after-sales service. A strong brand builds customer loyalty and makes demand less price elastic, so exporters can raise prices without losing many sales.
• The skills of the workforce, which affect both quality and productivity. A highly skilled workforce also helps firms adopt new technology and produce the complex, high-value goods in which advanced economies specialise.

Over the long run, non-price competitiveness matters at least as much as price. Countries such as Germany and Switzerland export successfully despite high wages and strong currencies because of the quality and reputation of their products.

The significance of international competitiveness

Benefits of being internationally competitive

• Export-led growth. Rising exports increase aggregate demand and economic growth. Through the multiplier, the final rise in national income is greater than the initial rise in exports.
• Jobs. Strong export industries create employment, often in well-paid sectors. Spending by these workers also supports jobs in local supply chains and services.
• A stronger current account, as exports rise and domestic firms compete successfully against imports. This reduces the country's reliance on borrowing from abroad or selling assets to finance a deficit.
• Attracting inward investment. Foreign firms are drawn to economies with productive workers and good infrastructure, which brings capital, technology and further jobs. Nissan, for example, chose to build its car plant in Sunderland partly so it could export to the rest of Europe.
• Higher living standards, because productive economies can pay higher real wages. Consumers can also gain if strong export demand raises the value of the currency, making imports cheaper.

Problems of being internationally uncompetitive

• A worsening current account, as exports fall and imports take a larger share of the domestic market. A persistent deficit has to be financed by borrowing or selling assets to foreigners, which may not be sustainable.
• Unemployment, especially structural unemployment in industries that cannot compete, concentrated in particular regions. The decline of UK coal, steel and shipbuilding in the 1980s left long-lasting unemployment in parts of the North of England, Scotland and Wales.
• Deindustrialisation, as manufacturing moves to lower-cost countries. Manufacturing now makes up a much smaller share of UK output than it did in the 1970s, while services have grown.
• Slower growth and lower tax revenues. Lower tax revenues, combined with higher spending on benefits, can widen the budget deficit.
• Pressure on the exchange rate, which may fall as demand for exports weakens. This can restore price competitiveness, but at the cost of higher import prices. Higher import prices can then feed through into inflation, reducing real incomes.

Improving competitiveness

Evaluation: Short-run gains in price competitiveness, such as a fall in the exchange rate or wage restraint, tend not to last. Lasting improvements usually come from the supply side: higher productivity through investment in education, skills, infrastructure and research.

These take years to work, which is why a country's competitiveness changes only slowly.

Key terms

Common mistakes

• Equating competitiveness with low wages. Productivity matters as much as wages, and high-wage countries can be highly competitive.
• Confusing unit labour costs with wages. Unit labour costs combine wages and productivity.
• Forgetting the exchange rate. Both measures change when the currency moves, even if nothing changes at home.
• Ignoring non-price factors. Quality, design and reputation are central to long-run competitiveness.
• Treating a depreciation as a lasting cure. It improves price competitiveness only temporarily, and raises import costs.

How this has been examined

In the Edexcel papers indexed on this site, this topic has appeared in four formats:

• 25-mark "Evaluate" essay — asked once (2023)
• 25-mark "Evaluate" synoptic essay — asked twice across 2 series (2017 to 2020)
• 2-mark "Explain" data response — asked twice in one series (2019)
• 1-mark multiple choice — asked once (2019)

Where this goes next

The exchange rate's effect on competitiveness is developed in 4.1.8 Exchange rates, and the current account in 4.1.7 Balance of payments. The supply-side policies that raise productivity are covered in 2.6.3 Supply-side policies. Competitiveness also shapes the 4.1.3 Pattern of trade and the costs and benefits of 4.1.1 Globalisation.