Real Exchange Rate: "The relative price of goods across other countries taking into account the varied rates of inflation"
Nominal ER x (PL in country / PL Abroad)
- Low interest rates decreases flow of hot money
- Decreased hot money flows decreases demand for pound
- Will cause the ER to decrease
- Causing an increase in strength of the pound
- Strong pound means exports will be more expensive
- Higher price will mean fall in international competetivness
- Depends on Price Elasticity of exports
- Floating exchange rate may self correct in long run
- Real ER depends on PL in other countries so is dependant on performance of trading countries
- Monetary motives may be priority so is necessary to lower interest rates
Why do wage costs affect international competetivness?
- Higher wage costs means higher AC for firm
- Higher Costs for firm means they must increase price to keep revenue constant
- Higher price will decrease demand
- Decreased demand shows reduction in competetivness
- To make international comparisons, figures are converted to a single currency and expressed as an index
- Change in demand will depend on elasticity highly elastic good may be able to change price and remain competitive
- Elasticity of exports depends on how dependant other countries are on that good, this will depend on severity of any trade blocs
- Firms may be able to reduce their own wage costs, but this is dependant on that industries union power, and also on goverment imposed NMW
Why does productivity affect international competitivness?
- Productivity is measured by comparing output per worker per hour
- Higher productivity reduces AC per unit output
- Reduction in AC means that price of exports can be reduced
- Reduction in price increases demand
- Increased demand shows increased international competitivness
- Changes in demand depends on elasticity of exports
- productivity refers to both capital productivity and labour productivity, both can be improved in the long run. Capital productivity improved through investment in R&D, labour productivity improved by govt investment in education and training
- Improvements in capital and labour productivity will be dependant on quality of R&D and education which is difficult to measure and impose.
Non Wage Costs
- National insurance
- Health and safety regulations
- Enviromental regulations
- Employment Protection
- Company pension schemes
All of the above will mean increased costs for the firm. Some of these mary be a lot more promiment in one particular country, for example employment protection is extremley low in the labour intensive industrial parts of china and south korea, however things such as health and safety regulations are quite common globally, hence no particular country will be at a great disadvantage with respect to that.