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Addressing competitiveness or financial fragmentation?

In explaining competitiveness developments in the EU, use is being made of the World Economic Forum Global Competitiveness Indicator. However, in its aggregated form, this index risks conveying deceptive policy recommendations.

By: and Date: January 8, 2014 Topic: European Macroeconomics & Governance

In explaining competitiveness developments in the EU, use is being made of the World Economic Forum Global Competitiveness Indicator. However, in its aggregated form, this index risks conveying deceptive policy recommendations.  The sharp fall in competitiveness observed in programme countries throughout the crisis is to be attributed largely to financial stress and the economic downturn, more than faltering structural reforms. A well-designed banking union has thus the potential to significantly contribute to a restoration of competitiveness in Europe.

During the past year, thanks to the European Central Bank (ECB)’s OMT announcement, we have assisted to an abatement of tension in sovereign financial markets. However, this development has not been associated with a return to growth. As explained by Mario Draghi during the ECB’s press conference on November 7, the recovery remains weak and uneven. To explain this phenomenon, a narrative is taking hold in Berlin, Frankfurt, and (in some cases) Brussels whereby crisis-ridden economies are dragging their feet[1] and thus “governments must decisively strengthen efforts to implement the needed structural reforms […] with a view to further improve competitiveness”[2].

To illustrate this point, heavy reliance is being made within EU policy circles on the World Economic Forum(WEF)’s Indicator of Global Competitiveness (GCI)[3]. As revealed by Der Spiegel[4], at an early October preparatory meeting for the October 25 European Council, “a representative of the European Central Bank presented a series of charts (of the sort of the one below, Ed.) showing a significant decline in competitiveness […] over the last seven years”.

Source: Der Spiegel based on WEF

Once a year, the Swiss non-profit organisation assembles the GCI based on a wealth of publicly available data (World Bank, OECD, World Trade Organisation, etc.) and a purposely devised Executive Opinion Survey.  Over a hundred variables, divided into 12 pillars, are then wisely aggregated using different weights, depending on the stage of development of an economy. However, looking at the aggregated GCI ranking (or at the ranking of its sub-components) does not allow to capture the different relative importance of each individual pillar.

To explain the point, we have downloaded WEF data (at pillar level) for programme countries and Germany for 2006 and 2013, in line with the chart above. Applying the weights used by the WEF, we have then computed the contribution of each pillar to the change in the overall GCI score. This resembles somewhat the macroeconomic concept of contribution-to-GDP-growth, applied however to GCI competitiveness. The results are worth reflecting.

Source: Bruegel calculations based on WEF data
Note: the uniform leap in Technological Readiness is likely to be due to a change in the composition of the pillar, to the benefit of more advanced economies.

The finding that GCI competitiveness has been sliding over the past seven years in Greece, Ireland, and Portugal is obviously confirmed. However, by looking at the individual pillars, we realise that in all cases, the strongest drivers of this decline were to be found under the financial development and macroeconomic environment headings. As a corner case, Ireland’s fall in competitiveness has been almost entirely driven by these two pillars.

Regarding the worsening macroeconomic environment, we will not enter into the whole austerity versus growth debate but only mention that the state of public finances is unlikely to sharply improve anytime soon, even under the most benign structural reform assumptions, as discussed by the latest IMF Fiscal monitor[5].  With respect to financial market development, we would highlight the fact that what is effectively captured by this pillar is the weakness of the banking sector and the worsening of firm credit availability. We would make the claim that these shortcomings are likely to be addressed more by a well-designed and fully effective banking union, on which European politicians should now focus, than by country-level structural reforms.

Source: Bruegel calculations based on WEF data

Briefly turning to Germany, given it is often adduced as the virtuous example to follow, we see that the (improving) macroeconomic environment, together with other elements, has contributed to the country’s rise in GCI competitiveness. Moreover, similarly to crisis-ridden economies (although to a smaller extent), financial stress has also significantly weighed on the competitiveness of the European front-runner.

To give a sense of how important it is to urgently fix the financial system in Europe, an exercise of comparative statics shows that, were countries to return to pre-crisis (sub-optimal but improved) levels of financial development, this would imply for some a significant improvement in their WEF competitiveness ranking. Worth mentioning are Portugal, which would have classified as 39th (rather than 51st) in the 2013-2014 WEF global ranking, and Ireland as 20th (rather than 29th).

All this is not to imply that structural reforms are not needed, in stressed countries or surplus economies, but rather that WEF data do not support the claim that competitiveness is sluggish in crisis-ridden countries as a result of faltering reforms. Actually, the sharp fall in competitiveness observed throughout the crisis is to be attributed largely to elements outside the direct control of national governments. Furthermore, a successful design and implementation of the banking union has the potential of contributing significantly at improving competitiveness in Europe.  Of course, this only if you believe in WEF-defined competitiveness, as EU top policy-makers seem to be doing.


[1] To rein this alleged policy-resistance to reform, core countries are even discussing the possibility of putting money on the table by means of reform contractual arrangements.

[2] Mario Draghi, Introductory statement to the press conference (with Q&A), 7 November 2013

[3] http://www.weforum.org/issues/global-competitiveness

[4] http://www.spiegel.de/international/europe/angela-merkel-has-a-new-ally-in-brussels-in-social-democrat-martin-schulz-a-930258.html

[5] http://www.imf.org/external/pubs/ft/fm/2013/02/pdf/fm1302.pdf


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