Friday, May 12, 2006

A Competitiveness "Paradox"
What's the link between the competitiveness of nations and economic growth?

IMD's World Competitiveness Rankings 2006, released this week, ranks China 19th and India 29th in global competitiveness. Hold on. Aren't those the fastest growing among the large economies of the world? I was intrigued enough to think deeper about the correlation between "competitiveness" and growth.

So I looked up the World Economic Forum (WEF)'s Global Competitiveness 2005 Report, which is pretty much the definitive work in this area. The results were no less intriguing. It ranks the US, Sweden and Denmark within the top 5 in competitiveness. I then looked at The Economist's predictions for GDP growth of these countries - the predicted growth for 2006 /2007 was in the range of 3.1% - 3.3% for each of these. And China and India, ranked 46th and 55th respectively in competitiveness by the WEF, are projected to grow at 8% - 10% ! There appears to be no relationship (if anything, the figures here even suggest an inverse relationship!) between competitiveness and economic growth. Admittedly there are many other countries in the list, but these examples are glaring enough to need an explanation in their own right.

What's wrong? Can it be that the notion of Competitiveness is entirely unrelated to growth? Not so. The WEF Competitiveness rankings report begins with the assertion that their aim is
"to shed light on the question of why some countries are able to grow on a sustained basis for prolonged periods of time..".

But this is where it gets difficult: How can countries that are not "competitive" grow the fastest, while the ones that are the most "competitive" grow much more slowly?!

In an attempt to find answers, I decided to see what the world's foremost authority on competitiveness (be it of companies or nations), Professor Michael Porter has to say. Prof. Porter, University Professor at Harvard, states in The Competitive Advantage of Nations:

"We must abandon the whole notion of a "competitive nation" as a term having much meaning for economic prosperity. The principal economic goal of a nation is to produce a high and rising standard of living for its citizens. The ability to do so depends not on the amorphous notion of "competitiveness" but on the productivity with which a nation's resources (labor and capital) are employed. Productivity is the value of the output produced by a unit of labor or capital."

Harvard Business School's Institute for Strategy and Competitiveness says on its website,

" based on the productivity with which a nation produces goods and services. Competitiveness is rooted in a nation’s microeconomic fundamentals—the sophistication of company operations and strategies and the quality of the microeconomic business environment in which companies compete."

Also, in ranking the competitiveness of nations, WEF uses quality of the macroeconomic environment, the state of a country’s public institutions, and, a country’s technological readiness. IMD uses Economic performance, government efficiency, business efficiency and infrastructure.

So, all the above makes things look a little better. It appears that the notion of competitiveness of a nation embraces a gamut of parameters, none of which can easily be correlated to GDP growth (and it may be simpistic to even try to do so).

However, the basic horse sense view would still be that a nation that scores highly on the competitiveness parameters - whether productivity and microeconomic fundamentals as the Harvard group avers, or the WEF or IMD's parameters - the economy of that nation must grow faster. In other words, to escape being a notion of purely intellectual significance, whatever we define as "competitiveness" must correlate well with growth.

Can it be that the GDP figures we are looking at are for the short term (2006/07), while "competitiveness", being a more holistic concept, determines growth in the longer term? Even this appears less than convincing. See what the Economist Intelligence Unit (EIU) projects for the period upto 2020: the EU will grow at 2%, and the US will grow at 2.9%, while China and India will grow at 5.9-6.0%!

That leaves a final explanation: the current low competitiveness rankings for China and India reflect the fact that these countries have historically been abysmally insular and inefficient. Even this theory looks less than bulletproof at first, because these countries' growth hasn't taken off dramatically in the last one or two years - they have been the fastest growing economies for much of the last decade, even while holding bottom-rankings in competitiveness. But this theory is somewhat vindicated by the fact that these countries' competitiveness rankings have steadily risen in the last few years. So the inverse correlation appears to be reducing, which at least raises the possibility of a trend towards a positive correlation in the next few years.

So, the paradox has been somewhat demystified, but survives unscathed!