INTERNATIONAL COMPETITIVENESS ESSAY

MACROECONOMICS
[SAMPLE ASSESSMENT MATERIAL (H060/2)]
EVALUATE, WITH THE AID OF AN APPROPRIATE DIAGRAM(S), THE POTENTIAL
IMPACT ON THE UK ECONOMY OF AN IMPROVEMENT IN ITS INTERNATIONAL
COMPETITIVENESS (20)
KNOWLEDGE (DEFINITIONS):

• International competiveness is the degree to which a country can, under free market
conditions, meet the test of international markets, while simultaneously maintaining
and expanding real incomes
APPLICATION / ANALYSIS:

• An improvement in international competitiveness can take the form of a fall in the

exchange rate. A lower exchange rate would make exports cheaper and imports more
expensive, causing the quantity demanded of exports to increase and the quantity
demanded of imports to decrease. This would likely result in increased export revenue
and lower import expenditure, which would both contribute to a rise in AD (because net
exports is a component of AD) and an improvement in the balance of payments position
(due to an improvement in the trade balance and thus the current account). Foreign
direct investment (FDI) may also be attracted into the UK, as improved international
competitiveness can be seen as a sign of advanced technology, high labour productivity,
low labour costs, a business friendly environment etc… Higher FDI would contribute
both to an increase in AD (as investment is a component of AD) and an increase in the
productive potential of the UK, and thus LRAS (due to an increase in the capital stock)
• The graph above shows this with AD increasing from AD to AD1 and LRAS increasing from
LRAS to LRAS1. This causes real output to increase from Y0 to Y1, productive potential to
increase from YFC to YFC1, and also the price level to increase from P0 to P1. The large
increase in both short run and long run economic growth, combined with only a minimal
increase in inflation, are signs of the UK achieving high and sustainable growth, whilst
maintaining a low and stable rate of inflation. Additionally, the rise in real output will
likely lead to a rise in employment. This is because labour is a derived demand, not
wanted for its own sake, but for the level of output it can produce and what that output
can be sold for. Furthermore, the potential effects may be even greater as the rise in net
exports and investment will have a multiplier effect, resulting in an even greater final
change in real output due to a second shift of AD

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MACROECONOMICS
EVALUATION:
• It must be noted, however, that the extent of the positive impact on the UK economy, or
even whether or not the impact is positive at all, is dependent upon other factors
• One limiting factor on the potential positive impact of a rise in the UK’s international
competitiveness, is the relative competiveness of the UK’s international competitors. If,
in the same time period, the UK’s international competitors become more
internationally competitive, to a greater extent than that of the UK, the final impact may
be more negative. This would be because firstly, the UK would not receive the benefits
of an improved trade balance (higher X-M) or increased FDI, and so the UK would not
get the higher short run or long run economic growth claimed in the analysis before.
Secondly, would be because FDI may be attracted to the UK’s international competitors,
potentially resulting in further technology and productivity gains in the UK’s competing
economies, which would then mean that AD could actually fall in the UK (due to lower X-
M), resulting in lower short run economic growth
• Another limiting factor on the potential positive impact of a rise in the UK’s international
competitiveness, is the extent to which the UK’s international competitors employ
protectionist measures. If our main trading partners become concerned about their own
lack of competitiveness, it is possible that they may impose tariffs on our exports and
also subsidise their own exporters. The higher tariffs would increase the price of our
exports, which would make them less price competitive and likely result in a fall in
export revenue for the UK. The subsidising of their exporters would mean that their
exports would become artificially cheaper, resulting in them becoming more price
competitive with domestic UK products, likely resulting in higher import expenditure in
the UK. The fall in net exports would likely decrease AD, real output, employment and
also worsen the balance of payments position (worsened current account due to
worsened trade balance)
• Finally, the last limiting factor on the potential positive impact of a rise in the UK’s
international competitiveness, is the PED of exports and imports. The marshall-lerner
condition states that a fall in the value of a currency will only improve the trade balance
if the sum of the |PEDs| of exports and imports is greater than 1. This is unlikely to
occur in the short run due to suppliers being locked in fixed trading contracts, and also
due to consumers and suppliers not being fully aware of changes in prices. As a result, if
the increase in UK competitiveness was caused by a fall in the value of the pound, the
trade balance could actually get worse

• The above graph shows that, in the short run (T0 to T1), the impact on the UK is likely to
be negative as the UK would see a fall in AD (lower X-M), lower real output, lower
employment and also a worsened balance of payments position. In the long run,

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 INTERNATIONAL COMPETITIVENESS ESSAY
MACROECONOMICS
however, the trade balance could improve, thus producing the positive effects outlined
in the earlier analysis. As a result, the impact on the UK economy will depend on the
time period being examined

JUDGEMENT:
• Balancing both sides of the argument, the potential impact on the UK following an
increase in its international competitiveness, is likely to be positive, however, the extent
to which it will be positive will be dependent upon a range of factors. Increased
international competitiveness will almost always, in the long run, only improve the
potential prospects of an economy such as the UK. It provides the potential to improve
all of the macroeconomic performance indicators at once, potentially providing an array
of benefits to all economic agents in the UK. Such benefits, however, may be limited by
changes in external factors, and in the case of exchange rates, likely only improve
economic indicators in the UK after some period of time known as the ‘long run’ has
passed. This means that the overall impact on the UK could be either positive or
negative, and so the overall impact on the UK, in truth, is not entirely known, however,
it is more than likely the final impact will sway more to the positive side

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