Measures of Competitiveness
I. Relative export costs
- The UK measures international competitiveness through relative costs of British exports. If UK goods and services become more expensive than other countries, the we will see a decline our international competitiveness.
Terms of trade measures =index of export prices
Index of import prices
Terms of trade measure the average export prices by the average import prices, it is a measure of a country's relative competitiveness.
If export prices rise relative to import prices, there has been an improvement in the terms of trade. One unit of export buy relatively more imports.
I import prices rise relative to export prices, there has been a deterioration in the terms of trade.
The effect of devaluation on the terms of trade
- If a currency falls in value, then we would expect to see an increase in the price of imports. We would need to pay more in pounds sterling to buy the same quantity of foreign goods. Since 2007, the pound sterling has dropped in value by 20% as a result imports have increased by 15%. This means that foreigners have been able to buy more British exports because the euro buys more pounds than it had previously. We would expect to see competitiveness increase.
This means that since July 2007, the UK's terms of trade should have been reduced. However, the terms of trade has not fallen because export prices continued to rise by 15% despite a fall in the value of pound sterling in comparison to the Euro.
Why might UK Export prices be rising?
- Demand for UK goods is relatively inelastic. And so, the producers raised their prices when the value of the pound depreciated
- If demand for UK exports was more elastic, there would be more incentive to keep prices low and try and increase sales.
- Supply is inelastic. The greater profitability of exports has so far not encouraged more firms to enter the market and reduce export prices. In the future, the greater profitability of exports may encourage higher supply in exports reducing profit margins and prices of exports.
II. Productivity and Unit costs of Production
An increase in the relative productivity of UK production means that an industry can produce more goods or services withlower costs this means that the UK will become more competitive.
III. Current Account/ Balance of Payments
If the current account improves then the value of exports has increased faster than imports, suggesting an improvement in competitiveness.
The persistent UK current account deficit, suggests a decline in competitiveness.
Factors that determine Competitiveness
Relative inflation rates