WTO: 2011 NEWS ITEMS

ECONOMIC RESEARCH AND ANALYSIS

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Professor Ir. Sudjarwadi, Rector of Universitas Gadjah Mada.  Mr. Riza Arfani, Executive Secretary of the Centre for World Studies. Distinguished guests and participants.  Selamat pagi.

Let me begin by saying that while the WTO system is one which provides the conditions to facilitate competitiveness,  there is no official WTO view on competitiveness and so what I offer are my own perspectives on the subject.  I will also discuss what the WTO, in its own way, is doing to increase the competitiveness of its members, in particular for its less developed members. 

 

Some general issue relating to competitiveness

First a few general issues in the context of competitiveness.

To understand competitiveness in its relevant context, we need to bear in mind that it is not an objective independent of its contribution to other more basic objectives such as growth of income, productive capacities and improved levels of well-being.  These are all dynamic concepts and therefore, competitiveness should be seen as creating enabling conditions to achieve these objectives through specific, positive and continued consistent efforts over time.

In broad terms, competitiveness is an ability to compete. If we search the internet for the definition for competitiveness, a common one would consider it in terms of the ability of a firm, sub-sector or a nation to compete.

Each of these entities, be they firms or nations, make efforts to enhance competitive ability.  At their own level, they take steps and establish systems which contribute towards increasing competitiveness.  That is an important context within which the multilateral trading system or the WTO becomes relevant.  More on this in a short while.

Competitiveness implies a willingness to engage and make efforts to gain grounds in an ever-changing world.  By its very nature, it does not imply that we build exclusive enclosures around ourselves.  In today’s world, such a policy is impossible to sustain.  Commercial enterprises as well as policy makers have to continuously build upon their competitive strengths.  In our interconnected world, this is an imperative for us all.

This interconnected world is also reflected in economic policy analysis.  Whether we consider microeconomics or macroeconomics, theories of development, finance or trade, the evolution of knowledge has involved an explicit recognition of the fact that people, firms or nations are not isolated entities. For example, policy makers today cannot conduct macroeconomic policies without taking account of the international sector. 

Due to the presence of such inter-linkages, stable, predictable and growing international opportunities have a far wider impact than just the direct positive benefits through international trade and investment.  This is because in several instances the effectiveness and efficiency of domestic policies, including the policy initiatives taken to improve competitiveness, are affected by the conditions prevailing in the international sector.  

Therefore, it is no surprise that nations have worked together to establish a system which provides stability, predictability and growth in international markets.  The WTO is precisely such a system, with its framework emphasizing   good governance, due process, transparency, credible dispute settlement and reducing arbitrariness in the area of international economic relations.   This was one of the reasons for Minister Pangestu in January this year at Davos to emphasise that there is no alternative to the multilateral trading system.

 

More detail on competitiveness

With this background, let us take a closer look at some of the underlying aspects about increasing competitiveness.  The work of Professor Porter has shown that improving competitiveness involves application of both macro and micro level policies, especially a careful consideration of the micro-economic foundations of competitiveness.1 

The last decade has seen several growth theorists reaching similar conclusions on the importance of the microeconomic factors emphasised by Prof. Porter.  Their results show that competitiveness and growth can be improved substantially through appropriate micro-economic policies to create and improve an investment and innovation friendly environment.

It is therefore interesting to note that both theoretical insights and experience suggest that there are good and bad ways of thinking about competitiveness, and consequently there are good and bad ways for governments to try and achieve it. In a famous article in Foreign Affairs, Paul Krugman expressed misgivings about countries’ obsession with competitiveness.2  He argued that from a theoretical standpoint, the notion of countries competing against one another in the same sense that Coca-Cola competes with Pepsi-Cola is simply wrong.  He cautioned us that focusing on competitiveness poses dangers to economic, and in particular, trade policy. Governments’ fixation on  competitiveness can lead countries down the road to industrial policy where politicians and bureaucrats take decisions about which industries are likely winners and losers and which domestic industries are to be given preferential support.  Or policymakers can become obsessed with the idea that competitiveness is measured by the trade balance, of producing an excess of exports over imports, which brings us to a view of trade as a zero-sum game and to the likelihood of perennial trade conflicts.  

Now I am not saying that there could not be instances when enterprises could be considered strategically important to their countries.  In such cases, there may be some truth to the notion that countries, by supporting their strategic national champions, will compete against one another in pretty much the same way as private firms do. 

Nevertheless, I believe that Krugman’s critique is correct.  At the same time, his views can be reconciled with the ideas of Professor Porter who also does not call for governments choosing winners and losers.  It is also consistent with the most recent strand of research in international trade which puts firms at the centre of the analysis.  The traditional focus of international trade theory was countries.  If you recall, David Ricardo’s classic example used England and Portugal to illustrate the principle of comparative advantage.  It took nearly two centuries before Krugman’s research (the so-called new trade theory) brought the focus of analysis down to industries and intra-industry trade.  The latest strand of economic research called the “new new trade theory” brings down the analysis further to the level of firms. 

 

What the new research tells us

New research tells us that firms that export are highly productive but often form only a minority of the enterprises that exist in a country.   For example, of the 5.5 million firms operating in the United States in 2000, just 4% were exporters.3  Among these exporting firms, the top 10% accounted for 96% of total US exports.  These exporting firms are very different from those that do not export.  They are larger, more productive, more skill- and capital-intensive, and they tend to pay higher wages.  These more productive firms elect to participate in international trade.  They are the firms which provide us with good models to understand how to become more competitive since they are better able to deal with the various costs of doing business, such as the cost of information about demand conditions abroad, of establishing a distribution system, or of meeting foreign product standards. 

New empirical research also tells us that competitive exporting firms sell a wide range of products to a large number of destinations, and that export growth takes place primarily through the entry of new firms, the introduction of new products, and the opening up of new export markets (what is referred to as the extensive margin of trade).   The WTO system is crucial for providing and enhancing such opportunities.

Recent research also gives us new insights into the composition effect of how productivity or competitiveness of a country is improved.  This is based on the micro-level intra-industry insight that policies that result in a reallocation of resources within an industry from the less productive firms to the more productive firms would increase an economy’s productivity or competitiveness. Thus, competition through trade opening or liberalization will increase the overall productivity of an industry because the least productive producers exit the market and their share of the market is taken up by the more productive firms who are usually involved in exporting.  Please note that such a change takes place due to the increase in the composition of more efficient firms within an industry.  This is a different channel of welfare gain than that identified in the traditional comparative advantage story where the re-allocation of resources is between industries. 

The new research produces quite specific advice to policymakers who wish to increase the competitiveness of their economy. 

One is that policies which rationalise and simplify the conditions of doing business increase the economy’s overall productivity and competitiveness.  Reducing such costs allows more firms to compete and engage in international trade.  As they expand in size, resources are reallocated to these more efficient firms from the less competitive domestic firms. 

Second, increasing competitiveness does not require policymakers to pick winning industries.  This is because within an industry you have quite a mix of firms, where some are very productive and therefore trade a lot, while others are not as productive and are confined to serving the home market. So it does not necessarily make sense to support an entire industry because that would involve subsidizing a lot of unproductive firms as well. 

Third, improving the ability of firms to tap the international market is an important way of increasing competitiveness.  This includes establishing systems which reduce non-recurring costs that keep firms from entering these markets in the first place, such as market information costs, or the cost in certifying that the features of your product satisfies the technical regulations of the importing country, or the cost of setting up a distribution system for your goods.  This suggests that policymakers eager to boost the competitiveness of their countries will need to focus more of their attention on areas like trade facilitation, technical barriers to trade, better infrastructure and capacity to improve distribution services.

Fourth, if policymakers are to intervene, they should do so less with the intention of inducing the same firms to sell more quantities of the same products to the same trade partners, than of expanding the set of firms who export and sell new products to new trade partners.  This means policymakers will need to focus on those obstacles that limit firms’ ability to export, to branch out into selling new products, or to penetrate new markets. 

Lastly, the bigger task for policymakers concerned with increasing competitiveness is to create an enabling environment where more of these productive firms can emerge. 

The WTO regime helps to achieve all these objectives by keeping markets open, reducing arbitrary policy interventions, and augmenting available opportunities and capabilities.

 

What are the appropriate policies?

What kind of environment provides the most fertile ground?   Professor Porter has shown that once certain conceptual adjustments are made, the same theory could be applied to competitiveness of nations, regions, and cities.  He emphasizes in particular the crucial role of macroeconomic stability, and sound political and legal institutions.  Within this context, the productive potential of firms depends on the factor input and market demand conditions faced by them, availability of related and supporting industries, the infrastructure which facilitates conditions of business, and the ability of the firm to handle strategic and rivalry issues.  An important insight is that the policy initiatives most relevant for any country depend largely on the levels of income and prevailing conditions within a country.  Furthermore, Professor Porter clarifies that the “stages of competitive development involve moving from being a factor-driven economy to becoming an investment-driven economy, and finally to becoming an innovation-driven economy”.  He also emphasises that instead of the government choosing winners and losers, it should create a general policy environment that reduces obstacles to business and encourages competitive conditions, including openness to international trade.

With this background, let us take a look at the ongoing empirical efforts to assess competitiveness issues regionally as well as globally.

Consider first the “ASEAN Competitiveness Report 2010” produced by the Asia Competitiveness Institute of Singapore, which has also examined the situation in individual ASEAN countries.  According to this Report, the top three areas of relative strength for Indonesia are: supporting and related industries and clusters; strategy and operativeness effectiveness; and, capital market infrastructure.  Likewise, the three key areas of relative weaknesses identified for Indonesia are: administrative infrastructure; communications infrastructure; and, human development.

Let us now go to a larger canvas covering the global situation, as shown by the work of the World Economic Forum (WEF) on its global competitiveness index.  Although the WEF’s competitiveness index was not developed to directly answer the question we have in mind, I think it is reasonably close and offers a good starting point. 

The WEF identifies twelve essential pillars of competitiveness.  They are the quality of institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation.  These pillars are not independent.  They can reinforce one another so that a strength (or weakness) in one area can have a positive (or negative) impact on other pillars. It is often easier to begin the improvements with a particular focus on the international trade sector.

I believe that in these twelve pillars the policymakers interested in encouraging highly productive enterprises have the critical areas where they could focus.  In this regard, Indonesia’s government has already done a very impressive job in improving on these pillars.  The World Economic Forum ranked Indonesia number 44 this year in terms of its global competitiveness index out of 139 economies included in the rankings.  Only six years ago, Indonesia was ranked number 69. So Indonesia has literally leapt up in the WEF’s global competitiveness ranking. 

These improvements have been apparent in Indonesia’s economic performance.  Over the last decade, average economic growth has been strong at 5.2% easily surpassing the global average of 3.6%.  Indonesia’s average GDP growth for the period 2011 to 2015 is forecast to be about 6.5 %.  With respect to international trade, over the last 10 years, the average annual rates of growth of Indonesia’s merchandise exports (9.2%) and commercial services exports (12.6%) have both exceeded the global average.  The Economist Intelligence Unit has estimated that by 2015, Indonesia’s exports and imports of goods will each be about double their levels this year.  These strong performances have led a number of global investors to argue for Indonesia to be considered similar to the BRICS.

Some of the policy prescriptions about improving a country’s overall productivity will only require changes to regulations and will not need governments to raise money.  However, other policy prescriptions will require governments to spend money or to develop expertise that it may not have at the moment. 

To address the resource constraints faced by developing countries, the WTO launched the Aid for Trade initiative during the Hong Kong Ministerial Conference in December 2005.  Aid for Trade is intended to help developing countries, particularly the least-developed countries, to overcome their supply-side constraints, increase their productivity and benefit from international trade.  By funnelling resources to the building of trade-related infrastructure, and in helping poor countries get their regulatory, business and trade policies right, the initiative helps create the economic environment from which more productive or competitive firms can emerge and participate more actively in global economic value chains.  

This July, the third global review of the Aid for Trade initiative was held in Geneva.  The results were very encouraging in several respects.  Aid for Trade flows have continued to grow reaching $40 billion in 2009 which represents an increase of 60% in these flows since 2005.  These levels have been maintained.  Further, the July review considered 260 case stories and 140 self-assessments by partner countries, bilateral and multilateral donor agencies, providers of South-South co-operation, and regional economic communities.  While the case studies are quite varied in nature, they showed that a significant number of Aid for Trade projects addressed product standards, customs reform and trade facilitation - areas which improve the competitiveness of domestic firms.  Thus, countries  reducing bottlenecks and barriers in these areas will see more of their firms involved in exporting and an increase in their productivity.  I am sure that the work done here by the WTO Chair will help both Indonesia and several other nations to raise their productivity and competitiveness.  

On this hopeful note, let me conclude by thanking you all for giving me the time to reflect on this important topic.  I understand that the able scholars assembled in this room will continue to discuss this issue further today.  I wish you every success in your endeavours.  Terima kasih.

1. B. Snowdown and G. Stonehouse (2006) “Competitiveness in a Globalized World: Michael Porter on the Microeconomic Foundations of the Competitiveness of Nations, Regions and Firms” Journal of International Business Studies 37: 163-175. back to text

2. P. Krugman (1994) “Competitiveness: A Dangerous Obsession”, Foreign Affairs 73, 2: 28-44. back to text

3. A. B. Bernard, J. B. Jensen, S. J. Redding, and P. K. Schott (2007) “Firms in International Trade”, Journal of Economic Perspectives 21, 3:105-130. back to text

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