1. So Now It Is All About Exports
GDP = Household Consumption + Investment + Government
Consumption
+ Net Trade (Exports – Imports)
Now if household and government consumption are falling
systematically, the only factor which can give a direct boost to GDP is the
relative movement in exports and imports. Positive movement here can
stimulate investment in the export (or tradeable) sector as expectations
build for increased demand.
Total Investment = Investment for Exports + Investment For Domestic
Demand.

2. Just Not Sufficiently Competitive?
While Italian exports surged back
after the financial crisis recession
they never in fact attained their pre-
crisis level, and now they are once
more declining again. In addition,
even though Italy’s goods trade
deficit has reduced substantially over
the last 12 months, it is still a DEFICIT.
As we can see in the chart on the
right, the Italian economy was on an
unsustainable path from the end of
2009 to mid 2011, as excessive
government spending fed an import
surge. As government spending was
cut this import boom burst, and
domestic demand collapsed, taking
the country deep into recession.

3. How To Define Competitiveness?
The issue of competitiveness has
become one generating more heat
than light in debate during the current
crisis. The validity of one
commonplace measure (REERs) widely
used historically has been repeatedly
questioned. In my opinion such
questioning has been largely motivated
by ideological and political motives in
contrast to scientific ones. In fact the
evidence is clear enough.
The REER (or Relative price and cost indicators) aim to assess a country's (or currency area's)
price or cost competitiveness relative to its principal competitors in international markets.
Changes in cost and price competitiveness depend not only on exchange rate movements but
also on cost and price trends. The specific REER for the Sustainable Development Indicators
is deflated by nominal unit labour costs (total economy) against a panel of 36 countries (=
EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New
Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate
REERs, reflecting not only competition in the home markets of the various competitors, but
also competition in export markets elsewhere. A rise in the index means a loss of
competitiveness. (Eurostat Definition)

4. Output & Productivity
High output per worker and high wages
are perfectly compatible. The road to
achieve this win-win combination is
through raising productivity, thus
maintaining unit labour costs constant,
or even reducing them.
As can be seen from the accompanying
charts, Germany achieved this combination
between 2000 and 2008, while Italy didn’t. In Italy
productivity stayed pretty much constant while
unit labour costs rose, meaning salaries rose
without the accompanying productivity, while in
Germany unit labour costs stayed constant while
productivity rose. This also gived the lie to the
“cheap German wages” argument, since if wages
hadn’t risen then ULCs would have fallen, which
they only did briefly between 2006 and 2008.

5. The problem in part is that value
added is often a sectorial issue.
For example agriculture and
construction have historically been
low value added and often high
unit labour cost sectors, whereas
petrochemicals or biotechnology
are high value added but also
often low ULC sectors, despite the
fact that wages are higher.
Naturally most societies would like to have a large proportion of high value added activities, and
a comparatively small proportion of low value added ones. But this isn’t as straightforward as it
seems, since the transition from agriculture to biotechnology doesn’t move along what we could
call a smooth production function. Namely you can’t simply transfer workers from one section to
the other. It ain’t that easy. The large number of construction workers recently displaced in Spain
can’t simply move into machine tool manufacturing, for example.
A countries ability to engage in what are high value activities at any moment in time depends on
key factors like the skill, education and experience levels of the workforce, and these change
only slowly. Critically the distribution of these factors depends to some extent on the age
structure of the population.

6. But in part the level of unit labour
costs depends on the level of
international competitiveness, which
in part depends how much of the
economy is in the tradeable sector
and how much in the non-tradeable
part of the economy. By tradeable we
mean in competition with other
producers or service providers
beyond the national frontier.
The key mechanism assumed here is that the tradeable sector, being exposed to external
competition, by definition needs to be more competitive to survive.
So a measure of a country’s lack of international competitiveness isn’t only that exports
are too small, it is also that imports are too big, which is another way of saying that the
domestic tradeable sector isn’t big enough. Normally this loss of competitiveness is
associated with a growing trade and current account deficit, which means the process of
non productivity supported rising living standards can only continue as long as some
external agent is willing to finance it. When confidence that the process is sustainable
subsides, people cease financing, and a crisis occurs. This is what happened to Italy in the
summer of 2011.

7. Export Dependency and International Competitiveness
But now I would like to introduce an additional concept which is generally not accepted
in mainstream economic theory, the idea of export dependent economies. Basically the
idea is that as populations age, demand for credit and with it the rate of increase in
domestic demand wanes. As can be seen in the chart on the right below, household
consumption in Italy surged in the 1990s, and the rate of growth in consumer demand
was quite rapid. The consumer boom was also linked to Italy’s last housing boom. Then
between 2000 and 2007 something changed, and the growth rate slowed. Any internally
coherent macro economic theory needs to be able to explain this change. Then following
the global crisis household consumption slumped, recovered slightly and then slumped
again.
So if we go back briefly to the earlier
chart on the composition of GDP, we
can perhaps formulate a new and
better definition of international
competitiveness, which would be
having an export sector which is
large enough and growing
dynamically enough to produce GDP
growth in an environment where
consumer demand weakens as
populations age.