Documents on Mexican Politics.

Competitiveness: A Dangerous Obsession

by Paul Krugman

Magazine: Foreign Affairs
Issue: March/April 1994 (volume 73, number 2)


Paul Krugman is Professor of Economics at the Massachusetts Institute
of Technology. His most recent book is "Peddling Prosperity: Economic
Sense and Nonsense in the Age of Diminished Expectations"
(W. W. Norton).


In June 1993, Jacques Delors made a special presentation to the
leaders of the nations of the European Community, meeting in
Copenhagen, on the growing problem of European unemployment.
Economists who study the European situation were curious to see what
Delors, president of the EC Commission, would say. Most of them share
more or less the same diagnosis of the European problem: the taxes and
regulations imposed by Europe's elaborate welfare states have made
employers reluctant to create new jobs, while the relatively generous
level of unemployment benefits has made workers unwilling to accept
the kinds of low-wage jobs that help keep unemployment comparatively
low in the United States. The monetary difficulties associated with
preserving the European Monetary System in the face of the costs of
German reunification have reinforced this structural problem.

It is a persuasive diagnosis, but a politically explosive one, and
everyone wanted to see how Delors would handle it. Would he dare tell
European leaders that their efforts to pursue economic justice have
produced unemployment as an unintended by-product? Would he admit that
the ems could be sustained only at the cost of a recession and face
the implications of that admission for European monetary union?

Guess what? Delors didn't confront the problems of either the welfare
state or the ems. He explained that the root cause of European
unemployment was a lack of competitiveness with the United States and
Japan and that the solution was a program of investment in
infrastructure and high technology.

It was a disappointing evasion, but not a surprising one. After all,
the rhetoric of competitiveness -- the view that, in the words of
President Clinton, each nation is "like a big corporation competing in
the global marketplace" -- has become pervasive among opinion leaders
throughout the world. People who believe themselves to be
sophisticated about the subject take it for granted that the economic
problem facing any modern nation is essentially one of competing on
world markets -- that the United States and Japan are competitors in
the same sense that Coca-Cola competes with Pepsi -- and are unaware
that anyone might seriously question that proposition. Every few
months a new best-seller warns the American public of the dire
consequences of losing the "race" for the 21st century.ffi A whole
industry of councils on competitiveness, "geo-economists" and managed
trade theorists has sprung up in Washington. Many of these people,
having diagnosed America's economic problems in much the same terms as
Delors did Europe's, are now in the highest reaches of the Clinton
administration formulating economic and trade policy for the United
States. So Delors was using a language that was not only convenient
but comfortable for him and a wide audience on both sides of the

Unfortunately, his diagnosis was deeply misleading as a guide to what
ails Europe, and similar diagnoses in the United States are equally
misleading. The idea that a country's economic fortunes are largely
determined by its success on world markets is a hypothesis, not a
necessary truth; and as a practical, empirical matter, that hypothesis
is flatly wrong. That is, it is simply not the case that the world's
leading nations are to any important degree in economic competition
with each other, or that any of their major economic problems can be
attributed to failures to compete on world markets.  The growing
obsession in most advanced nations with international competitiveness
should be seen, not as a well-founded concern, but as a view held in
the face of overwhelming contrary evidence. And yet it is clearly a
view that people very much want to hold -- a desire to believe that is
reflected in a remarkable tendency of those who preach the doctrine of
competitiveness to support their case with careless, flawed

This article makes three points. First, it argues that concerns about
competitiveness are, as an empirical matter, almost completely
unfounded. Second, it tries to explain why defining the economic
problem as one of international competition is nonetheless so
attractive to so many people. Finally, it argues that the obsession
with competitiveness is not only wrong but dangerous, skewing domestic
policies and threatening the international economic system. This last
issue is, of course, the most consequential from the standpoint of
public policy. Thinking in terms of competitiveness leads, directly
and indirectly, to bad economic policies on a wide range of issues,
domestic and foreign, whether it be in health care or trade.

Mindless competition

Most people who use the term "competitiveness" do so without a second
thought. It seems obvious to them that the analogy between a country
and a corporation is reasonable and that to ask whether the United
States is competitive in the world market is no different in principle
from asking whether General Motors is competitive in the North
American minivan market.

In fact, however, trying to define the competitiveness of a nation is
much more problematic than defining that of a corporation. The bottom
line for a corporation is literally its bottom line: if a corporation
cannot afford to pay its workers, suppliers, and bondholders, it will
go out of business. So when we say that a corporation is
uncompetitive, we mean that its market position is unsustainable --
that unless it improves its performance, it will cease to
exist. Countries, on the other hand, do not go out of business. They
may be happy or unhappy with their economic performance, but they have
no well-defined bottom line. As a result, the concept of national
competitiveness is elusive.

One might suppose, naively, that the bottom line of a national economy
is simply its trade balance, that competitiveness can be measured by
the ability of a country to sell more abroad than it buys. But in both
theory and practice a trade surplus may be a sign of national
weakness, a deficit a sign of strength. For example, Mexico was forced
to run huge trade surpluses in the 1980s in order to pay the interest
on its foreign debt since international investors refused to lend it
any more money; it began to run large trade deficits after 1990 as
foreign investors recovered confidence and began to pour in new
funds. Would anyone want to describe Mexico as a highly competitive
nation during the debt crisis era or describe what has happened since
1990 as a loss in competitiveness?

Most writers who worry about the issue at all have therefore tried to
define competitiveness as the combination of favorable trade
performance and something else. In particular, the most popular
definition of competitiveness nowadays runs along the lines of the one
given in Council of Economic Advisors Chairman Laura D'Andrea Tyson's
Who's Bashing Whom?: competitiveness is "our ability to produce goods
and services that meet the test of international competition while our
citizens enjoy a standard of living that is both rising and
sustainable." This sounds reasonable. If you think about it, however,
and test your thoughts against the facts, you will find out that there
is much less to this definition than meets the eye.

Consider, for a moment, what the definition would mean for an economy
that conducted very little international trade, like the United States
in the 1950s. For such an economy, the ability to balance its trade is
mostly a matter of getting the exchange rate right. But because trade
is such a small factor in the economy, the level of the exchange rate
is a minor influence on the standard of living. So in an economy with
very little international trade, the growth in living standards -- and
thus "competitiveness" according to Tyson's definition -- would be
determined almost entirely by domestic factors, primarily the rate of
productivity growth. That's domestic productivity growth, period --
not productivity growth relative to other countries. In other words,
for an economy with very little international trade, "competitiveness"
would turn out to be a funny way of saying "productivity" and would
have nothing to do with international competition.

But surely this changes when trade becomes more important, as indeed
it has for all major economies? It certainly could change.  Suppose
that a country finds that although its productivity is steadily
rising, it can succeed in exporting only if it repeatedly devalues its
currency, selling its exports ever more cheaply on world markets. Then
its standard of living, which depends on its purchasing power over
imports as well as domestically produced goods, might actually
decline. In the jargon of economists, domestic growth might be
outweighed by deteriorating terms of trade. So "competitiveness" could
turn out really to be about international competition after all.

There is no reason, however, to leave this as a pure speculation; it
can easily be checked against the data. Have deteriorating terms of
trade in fact been a major drag on the U.S. standard of living?  Or
has the rate of growth of U.S. real income continued essentially to
equal the rate of domestic productivity growth, even though trade is a
larger share of income than it used to be?

To answer this question, one need only look at the national income
accounts data the Commerce Department publishes regularly in the
Survey of Current Business. The standard measure of economic growth in
the United States is, of course, real gnp -- a measure that divides
the value of goods and services produced in the United States by
appropriate price indexes to come up with an estimate of real national
output. The Commerce Department also, however, publishes something
called "command gnp." This is similar to real gnp except that it
divides U.S. exports not by the export price index, but by the price
index for U.S. imports. That is, exports are valued by what Americans
can buy with the money exports bring.  Command gnp therefore measures
the volume of goods and services the U.S. economy can "command" -- the
nation's purchasing power -- rather than the volume it produces.\ And
as we have just seen, "competitiveness" means something diFFerent from
"productivity" if and only if purchasing power grows significantly
more slowly than output.

Well, here are the numbers. Over the period 1959-73, a period of
vigorous growth in U.S. living standards and few concerns about
international competition, real gnp per worker-hour grew 1.85 percent
annually, while command gnp per hour grew a bit faster, 1.87
percent. From 1973 to 1990, a period of stagnating living standards,
command gnp growth per hour slowed to 0.65 percent.  Almost all (91
percent) of that slowdown, however, was explained by a decline in
domestic productivity growth: real gnp per hour grew only 0.73

Similar calculations for the European Community and Japan yield
similar results. In each case, the growth rate of living standards
essentially equals the growth rate of domestic productivity -- not
productivity relative to competitors, but simply domestic
productivity. Even though world trade is larger than ever before,
national living standards are overwhelmingly determined by domestic
factors rather than by some competition for world markets.

How can this be in our interdependent world? Part of the answer is
that the world is not as interdependent as you might think: countries
are nothing at all like corporations. Even today, U.S.  exports are
only 10 percent of the value-added in the economy (which is equal to
gnp). That is, the United States is still almost 90 percent an economy
that produces goods and services for its own use. By contrast, even
the largest corporation sells hardly any of its output to its own
workers; the "exports" of General Motors -- its sales to people who do
not work there -- are virtually all of its sales, which are more than
2.5 times the corporation's value-added.

Moreover, countries do not compete with each other the way
corporations do. Coke and Pepsi are almost purely rivals: only a
negligible fraction of Coca-Cola's sales go to Pepsi workers, only a
negligible fraction of the goods Coca-Cola workers buy are Pepsi
products. So if Pepsi is successful, it tends to be at Coke's
expense. But the major industrial countries, while they sell products
that compete with each other, are also each other's main export
markets and each other's main suppliers of useful imports.  If the
European economy does well, it need not be at U.S. expense; indeed, if
anything a successful European economy is likely to help the
U.S. economy by providing it with larger markets and selling it goods
of superior quality at lower prices.

International trade, then, is not a zero-sum game. When productivity
rises in Japan, the main result is a rise in Japanese real wages;
American or European wages are in principle at least as likely to rise
as to fall, and in practice seem to be virtually unaffected.

It would be possible to belabor the point, but the moral is clear:
while competitive problems could arise in principle, as a practical,
empirical matter the major nations of the world are not to any
significant degree in economic competition with each other.  Of
course, there is always a rivalry for status and power -- countries
that grow faster will see their political rank rise. So it is always
interesting to compare countries. But asserting that Japanese growth
diminishes U.S. status is very different from saying that it reduces
the U.S. standard of living -- and it is the latter that the rhetoric
of competitiveness asserts.

One can, of course, take the position that words mean what we want
them to mean, that all are free, if they wish, to use the term
"competitiveness" as a poetic way of saying productivity, without
actually implying that international competition has anything to do
with it. But few writers on competitiveness would accept this view.
They believe that the facts tell a very different story, that we live,
as Lester Thurow put it in his best-selling book, Head to Head, in a
world of "win-lose" competition between the leading economies. How is
this belief possible?

Careless arithmetic

One of the remarkable, startling features of the vast literature on
competitiveness is the repeated tendency of highly intelligent authors
to engage in what may perhaps most tactfully be described as "careless
arithmetic." Assertions are made that sound like quantifiable
pronouncements about measurable magnitudes, but the writers do not
actually present any data on these magnitudes and thus fail to notice
that the actual numbers contradict their assertions. Or data are
presented that are supposed to support an assertion, but the writer
fails to notice that his own numbers imply that what he is saying
cannot be true. Over and over again one finds books and articles on
competitiveness that seem to the unwary reader to be full of
convincing evidence but that strike anyone familiar with the data as
strangely, almost eerily inept in their handling of the numbers. Some
examples can best illustrate this point. Here are three cases of
careless arithmetic, each of some interest in its own right.

Trade Deficits and the Loss of Good Jobs.

In a recent article published in Japan, Lester Thurow explained to his
audience the importance of reducing the Japanese trade surplus with
the United States. U.S. real wages, he pointed out, had fallen six
percent during the Reagan and Bush years, and the reason was that
trade deficits in manufactured goods had forced workers out of
high-paying manufacturing jobs into much lower-paying service jobs.

This is not an original view; it is very widely held. But Thurow
was more concrete than most people, giving actual numbers for the
job and wage loss. A million manufacturing jobs have been lost
because of the deficit, he asserted, and manufacturing jobs pay 30
percent more than service jobs.

Both numbers are dubious. The million-job number is too high, and the
30 percent wage differential between manufacturing and services is
primarily due to a difference in the length of the workweek, not a
difference in the hourly wage rate. But let's grant Thurow his
numbers. Do they tell the story he suggests?

The key point is that total U.S. employment is well over 100 million
workers. Suppose that a million workers were forced from manufacturing
into services and as a result lost the 30 percent manufacturing wage
premium. Since these workers are less than 1 percent of the U.S. labor
force, this would reduce the average U.S.  wage rate by less than
1/100 of 30 percent -- that is, by less than 0.3 percent.

This is too small to explain the 6 percent real wage decline by a
factor of 20. Or to look at it another way, the annual wage loss from
deficit-induced deindustrialization, which Thurow clearly implies is
at the heart of U.S. economic difficulties, is on the basis of his own
numbers roughly equal to what the U.S. spends on health care every

Something puzzling is going on here. How could someone as intelligent
as Thurow, in writing an article that purports to offer hard
quantitative evidence of the importance of international competition
to the U.S. economy, fail to realize that the evidence he offers
clearly shows that the channel of harm that he identifies was not the

High Value-added Sectors.

 Ira Magaziner and Robert Reich, both now influential figures in the
Clinton Administration, first reached a broad audience with their 1982
book, "Minding America's Business." The book advocated a U.S. 
industrial policy, and in the introduction the authors offered a
seemingly concrete quantitative basis for such a policy: "Our standard
of living can only rise if (i) capital and labor increasingly flow to
industries with high value-added per worker and (ii) we maintain a
position in those industries that is superior to that of our

Economists were skeptical of this idea on principle. If targeting the
right industries was simply a matter of moving into sectors with high
value-added, why weren't private markets already doing the job? But
one might dismiss this as simply the usual boundless faith of
economists in the market; didn't Magaziner and Reich back their case
with a great deal of real-world evidence?

Well, "Minding America's Business" contains a lot of facts. One thing
it never does, however, is actually justify the criteria set out in
the introduction. The choice of industries to cover clearly implied a
belief among the authors that high value-added is more or less
synonymous with high technology, but nowhere in the book do any
numbers compare actual value-added per worker in different industries.

Such numbers are not hard to find. Indeed, every public library in
America has a copy of the Statistical Abstract of the United States,
which each year contains a table presenting value-added and employment
by industry in U.S. manufacturing. All one needs to do, then, is spend
a few minutes in the library with a calculator to come up with a table
that ranks U.S. industries by value-added per worker.

The table on this page shows selected entries from pages 740-744 of
the 1991 Statistical Abstract. It turns out that the U.S.  industries
with really high value-added per worker are in sectors with very high
ratios of capital to labor, like cigarettes and petroleum refining. 
(This was predictable: because capital-intensive industries must earn
a normal return on large investments, they must charge prices that are
a larger markup over labor costs than labor-intensive industries,
which means that they have high value-added per worker). Among large
industries, value-added per worker tends to be high in traditional
heavy manufacturing sectors like steel and autos. High-technology
sectors like aerospace and electronics turn out to be only roughly

This result does not surprise conventional economists. High
value-added per worker occurs in sectors that are highly
capital-intensive, that is, sectors in which an additional dollar of
capital buys little extra value-added. In other words, there is no
free lunch.

But let's leave on one side what the table says about the way the
economy works, and simply note the strangeness of the lapse by
Magaziner and Reich. Surely they were not calling for an industrial
policy that would funnel capital and labor into the steel and auto
industries in preference to high-tech. How, then, could they write a
whole book dedicated to the proposition that we should target high
value-added industries without ever checking to see which industries
they meant?

Labor Costs.

 In his own presentation at the Copenhagen summit, British Prime
Minister John Major showed a chart indicating that European unit labor
costs have risen more rapidly than those in the United States and
Japan. Thus he argued that European workers have been pricing
themselves out of world markets.

But a few weeks later Sam Brittan of the "Financial Times" pointed out
a strange thing about Major's calculations: the labor costs were not
adjusted for exchange rates. In international competition, of course,
what matters for a U.S. firm are the costs of its overseas rivals
measured in dollars, not marks or yen. So international comparisons of
labor costs, like the tables the Bank of England routinely publishes,
always convert them into a common currency. The numbers presented by
Major, however, did not make this standard adjustment. And it was a
good thing for his presentation that they didn't. As Brittan pointed
out, European labor costs have not risen in relative terms when the
exchange rate adjustment is made.

If anything, this lapse is even odder than those of Thurow or
Magaziner and Reich. How could John Major, with the sophisticated
statistical resources of the U.K. Treasury behind him, present an
analysis that failed to make the most standard of adjustments?

These examples of strangely careless arithmetic, chosen from among
dozens of similar cases, by people who surely had both the cleverness
and the resources to get it right, cry out for an explanation. The
best working hypothesis is that in each case the author or speaker
wanted to believe in the competitive hypothesis so much that he felt
no urge to question it; if data were used at all, it was only to lend
credibility to a predetermined belief, not to test it. But why are
people apparently so anxious to define economic problems as issues of
international competition?