April 30, 2013

Competition in Context: National Economies

In last week's post I outlined five points about competition that tend to go overlooked in economic discourse:
  • The amount of things we are competing for changes over time.
  • The future amounts of things we are competing for are uncertain.
  • The things we are competing for may be created by the competitors themselves.
  • The amount of things we are competing for may be artificially constrained (this is basically a roundabout way of describing the way we often create markets using public or non-rivalrous goods).
  • The current allocation of things we are competing for may have important effects on the ability of competitors to compete for more of them (this is basically a roundabout way of describing things like economies of scale, network effects, path dependency, and first-mover advantage).
I want to take these ideas and look at what they can mean for competition situated in various contexts. What does it mean for a country to be competitive as compared with a competitive business or a competitive worker? I don't want to give a full account of how competition in these areas works, rather to think about why the points I've made above are important.

In all three of these competitive arenas, competitiveness comes from offering more value than competitors are offering. Typically 'offering value' means selling similar (aka substitutable) products or services more cheaply than a rival worker, firm, or country. Although these three realms of competition are similar in the abstract, they compete to provide that value in different ways. Today I'll write about competition in national economies.

National Economies

National economies compete with each other in a number of ways, most prominently in trying to attract international investment or run a positive balances of trade (by exporting more final and intermediate goods than they import from other countries). They also compete in other ways, by attracting immigrants or more overtly through war, but I will just consider trade and investment here.

Both investment and trade flows fluctuate significantly over time, and they do so in both net as well as gross terms. This fluctuation--the resizing of the pie the economies are competing for--can have important macroeconomic consequences for countries. These kind of changes in trade and investment are well-enough understood by economists, but they can be missing from popular rhetoric in important ways. For example, protectionist policies during the great depression are thought to have exacerbated the economic downturn, but were still pursued because lawmakers (evidently) failed to see how decreasing US imports could also eventually decrease US exports.

It is worth noting that since the 1970s competition between nations has had a sort of "equalizing" mechanism that should serve to dampen competition: free-floating exchange rates. In theory this means that nations are unable to trade their way into a larger stock of value--they are only able to trade for the value of what they are producing (or can convince other countries they will produce in the future). In basic neoclassical economic theory, therefore, countries are not "in competition" in the way that firms or workers are. In practice, however, trade flows can be heavily dependent on skewed terms of value exchange if exchange rates do not adjust flawlessly (or exist, in the case of Europe).

National economies also reflect the uncertainty of competition (e.g. nations may embark on ambitious industrial planning that fails to come to fruition in the long term) and the "self-determining pie" nature of the value being competed for (e.g. nations may fail to create enough domestic demand to grow internally without relying on trade export surpluses, like China). These misconceptions about competition can have important consequences, like wasted public investment or beggar-thy-neighbor pursuit of competitiveness that ignores the importance of domestic demand. Attempts to promote competitiveness need to reflect the complexities of the real world.

Finally, competition between national economies is also powerfully affected by network effects, path dependency, institutional strength, and other forces acting on markets outside of normal supply/demand issues. This has been recognized by economics but it has been a struggle to put it into practice for many countries: some countries have been successful, such as the "asian tigers" and more recently the BRICs, but others have been unable to harness these positive externalities for their competitive gain. Economics has incorporated some of these ideas into standard trade models but overall they fail to capture many ideas useful for policy.

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