Would Raising Competitiveness Solve the Problems of Europe and the World?

In the new world of globalization, a fashionable phrase after the financial crisis is, raising competitiveness.   A lunch tale from my own experience exemplifies how catchy this phrase is.  As the European sovereign crisis unfolded in April, I was having lunch with a large group of financial industry professionals, many of whom have master’s and Ph.D. degrees and at least a few years of experience in the financial industry, as well as CFA designations.  At the time, the Greek sovereign CDS shot out of the roof, and our discussion inevitably touched on the crisis in PIIGS countries.  The sentiment at the table was that these countries deserve to suffer unless they can raise their competitiveness through internal deflation, and that these countries are too small to affect the global economy, and we can just leave them alone. 

I was the lone dissident.  I tried to explain that in today’s world of deep globalization, “no man is an island.”  When the bell tolls, be prepared to help instead of standing aloofly.  I also tried to explain that the problem for the world today is not a lack of competitiveness, but unbalanced growth.  In fact, a lack of competitiveness cannot exist for the world as a whole.  After all, competitiveness is always in relative terms. 

A few days later, the unfolding events quickly proved that we couldn’t stand aloofly while the crisis spread.  At the time, the possibility of contagion started to shake up European markets, as well as the U.S. markets. 

It is the other point that is more difficult to prove, and I think it deserves some explanation.  Take the Eurozone as an example.  It is well known that Germany raised competitiveness relative to the other European countries during the last decade after a painful post-unification digestion period in the 1990s.  As a result, the unit labor cost, which is the most important cost for most developed countries, is lower in Germany than in other European countries.  As a result, even though the Eurozone has largely balanced trade with the rest of world, countries like Germany run a large trade surplus against the rest of Eurozone.  The unbalanced trade and growth within the  Eurozone is the root cause of today’s European crisis. 

Even though PIIGS countries could catch up to the German standard of productivity, it does not solve the world’s problem.  Rising competitiveness in these countries might balance the trade within the Eurozone, which is currently the biggest problem, however, it also would transform the Eurozone as a whole from a region with balanced trade with the rest world to another East Asia.  That would be a nightmare for the whole world. 

In nominal terms, the Eurozone GDP is close to that of East Asia as a share of the world’s GDP.  Combined at today’s exchange rate, these two regions produce close to half of the world’s GDP.  Intuitively, for the whole world, we know that the total amount of exports and imports have to equal each other, and the total amount of trade surplus have to equal that of trade deficit.   Thus, if the Eurozone were to run a level of trade surplus as a percentage of its GDP similar to that of East Asia due to their newly gained competitiveness, the rest of the world will have to consistently run at least as high a level of trade deficit as a percentage of GDP.  In the long term this is mathematically impossible, unless we can export to Mars. 

More importantly, a single-minded focus on raising competitiveness would threaten the current globalization process, which has been largely peaceful to date.  The first half of the 20th century is a period when nations focused single-mindedly on raising competitiveness; we all know that the outcomes were trade wars and World Wars.  Instead, for globalization to stay its course going forward, the fashionable phrase, and the only solution, should be balanced growth.