Department of Economics Uppsala University D-thesis Writer: Amanda Eriksson Tutor: Per Engström Spring 08 The development of Competitiveness - A theoretical approach in a European context. Abstract The aim of this paper is to theoretically establish a framework for the basics of international trade between countries creating competitiveness. Since the environment in which trade takes place is changeable so is the concept of competitiveness. It is therefore argued in the paper that in order to understand the underlying factors of competitiveness one have to understand the environment in which trade takes place in. Today the concept of competitiveness will therefore be better understood by employing an industrial perspective. This approach can answer questions, which national aggregate estimates cannot. The question asked in the paper is; which industries in Europe, based on the assumptions of international trade theories is competitive? The European industries that came out as competitive were the one using high- skilled labor and produced or used ICT intensively in their production. The question also provided some answers to the always up-do-day wonder namely, in which direction European competitiveness is heading. Key-words: Competitiveness, Traditional trade theories, New trade theories, Comparative advantages. Table of Contents 1. INTRODUCTION ............................................................................................................ 1 1.1 Aim and scope ....................................................................................................................................... 2 1.2 Competitiveness, a question of definition ............................................................................................. 4 1.3 Competitiveness, a dangerous obsession ............................................................................................... 7 1.4 Disposition ............................................................................................................................................. 8 2. TRADITIONAL TRADE THEORY ............................................................................... 9 2.1 Gains from trade ................................................................................................................................... 9 2.1.1 The Factor- Proportions theory ...................................................................................................... 12 2.2 Effects of trade ..................................................................................................................................... 13 3. NEW TRADE THEORY ................................................................................................ 15 3.1 Explaining Intra-industry trade with Differentiated Products .......................................................... 15 3.1.1 Monopolistic competition............................................................................................................... 16 3.1.2 Economies of scales ...................................................................................................................... 16 3.2 Traditional versus New trade theory .................................................................................................. 18 4. COMPETITIVENESS –AN EVALUATION ............................................................... 20 4.1 Empirical findings for competitiveness in European industries ........................................................ 21 4.2 Combining Traditional and New trade theory ................................................................................... 24 5. DISCUSSION ................................................................................................................. 26 6. REFERENCES .............................................................................................................. 29 APPENDIX ............................................................................................................................ 1. Introduction To many observers, the European Union (EU) appears to have been losing competitiveness in the global economy over the past decade. The perception of declining EU competitiveness has in turn led to more urgent calls for deep structural reforms, for example see O‟Mahony and Van Ark (2004). In 2006 the European commission launches Global Europe, a policy document stating that the internal agenda for European competitiveness should be complemented with an external agenda. Global Europe advocates further liberalization of the Union towards external markets. It sets out; in a rapidly changing global economy, Europe can build a more comprehensive, integrated and forward-looking external trade policy that makes a stronger contribution to Europe's industries competitiveness, by further liberalization towards external markets (European Commission, 2006). As a first result of this proposal, questions are now being raised on how different industries in the EU will react to the proposal of further liberalization? In spite of nearly universal concerns over competitiveness, how to gain it and how to maintain it there is, however, surprisingly little coherent discussion of what “competitiveness” really is, and why it is so important. The predominant view of the expression is to think of it as competition among countries just as competition between corporations, but in a larger scale (Krugman, 1996). This way of thinking in terms of”win- lose” competition between leading economies is wrong, since countries are in fact fundamentally different from corporations. Indeed, trade between countries is so much unlike competition between corporations that many economists regard the word ”competitiveness” misleading as to the point to be meaningless when applied to countries (Krugman, 1996). This kind of problems will be more comprehensive discussed later on in the paper. People worrying about European competitiveness are not raising their concern out of thin air. They are responding to a perception that the EU actually has been, or are about to lose something important in the process of international competition. Over the past decade competitive markets have helped European manufacturing industry broadly maintain its share of GDP in the face of globalization (European Commission, 2006). But recently, as it seems, the EU are losing ground against the US (Hamilton & Quinlan, 2008). A measure frequently used when comparing competitiveness between countries is annual growth rates in real GDP, 1 for example see the discussion in OECD (2003). In table 1.1 annual growth rates in real GDP is shown. The annual growth rate in real GDP is the same in Europe between the two periods while it has increased in the U.S. Bowen and Sleuwaegen (2007) have estimated that the European GDP per capita in real prices in 2000 only was 71% of the US GDP per capita in real prices. They have established the primary cause of this cap in GDP to depend on lower rates in labor productivity and in total hours worked in Europe. Aggregate annual growth rates in % of real GDP, total hours and labor productivity, 1987-2007 real GDP total hours GDP/hour EU(15) US EU(15) US EU(15) US 1987-1995 2,3 2,7 0,1 1,6 2,2 1,2 1995-2007 2,3 3,1 0,9 1,0 1,4 2,1 EU(15) referring to membership of the European Union until 30 April 2004. Source: The Conference Board and Groning Growth and Development Center, Total Economy Database, January 2008 Table 1.1 But what do these findings really imply? Some observers believe that the US has experienced a structural break leading to somewhat faster productivity growth, continuing into the first decade of the 21st century. For example see O‟Mahony & Van Ark (2003). While others suggest that it might be the EU that has entered a productivity slowdown of structural nature. Either way without knowing what it is that creates European competitiveness, incentives in order to increase competitiveness can be quite ineffective. But since the view of seeing a country just like being a corporation can be quite wrong and misleading, lack of understanding for the evolving changes in the competitive environment facing EU industries can, indeed, be just as damaging to a country‟s economy is one the other hand right (Krugman, 1996). In this paper it is therefore argued that in order to understand the underlying factors of competitiveness one have to understand the environment, the context in which trade takes place in. The concept of competitiveness will therefore be better understood by employing an industrial perspective. This approach can answer questions that aggregate economy estimates cannot. 1.1 Aim and scope The aim of this paper is to investigate which industries in Europe that can be seen as competitive, by answering the question; which industries in Europe, based on the assumptions of international trade theories is competitive? 2 In order to answer this question the concept of competitiveness has to be defined from the context in which it is used in, since the concept is subject to a wide range of different definitions in different contexts. In this paper, however, competitiveness will be seen as a product of trade between countries resulting in increased potentials to wealth, and is therefore desirable. In a simplified way competitiveness can be seen as a tool creating potentials to increased wealth via trade. But since the environment in which international trade take place in is changeable, so are the presumptions for competitiveness. In order